A (2:55)

And with that, please enjoy this wide ranging and thoughtful conversation with my guest, Jim Bianco.

B (3:05)

Jim Bianco, welcome to Hidden Forces.

C (3:09)

Thanks for having me.

B (3:11)

This is a long time in the making, Jim. We've known each other for a long time. I look back on my emails because I could have swore that we had something scheduled in the past and we did. But I don't entirely know what led to us having to cancel and we never rescheduled. So I'm glad we were able to finally make this happen.

C (3:24)

Yeah, I am too. I've been a longtime listener of Hidden Forces and I think you do a great job with your interviews and I'm looking forward to it.

B (3:32)

I appreciate it, Jim. So for people who either know you, because like lots of people know you, you're always on. You're one of these people that sort of achieved escape velocity in media. And you were in legacy media before mainstream, before alternative media took off where like everybody got on media. So you still make appearances on cnbc. How did you get started in this business?

C (3:52)

I got started in this business out of college. I graduated, you know, in 1984. And I got started on Wall street in the late 1980s. And from there I started in the Equity Research Department at First Boston. That's before it was known as Credit Suisse. I worked there for a couple years. I moved to UBS, Phillips and Drew in around 1989, 1990. And I say that because that's became UBS Warburg. And now it's not just known as UBS. When I worked at UBS, Phillips and Drew, it was less than 100 employees in New York. Now it's thousands of. And then in 1990, I moved back to Chicago, which is where I'm born and raised, and I started working with a little brokerage firm located here, an institutional brokerage firm called Arbor Research and trading. And from 1990 to 1998, I was their director of research. And then after 1998, we spun me off into Bianco Research Media. You know, it's interesting, I got to know Jim Grant in the 1990s. I got to know Ron and Sana in the 1990s. And Sana was probably the guy that got me on the CNBC kind of in the mid to late 90s. And then it just started to kind of go from there. I was a regular on those. And then there was this old network you might remember, CNN Financial News, CNN, FN and when they started up in, like, 97 or something like that, I actually had a weekly bit called James on the Bond where I'd come on in every Friday and talk about the bond market. And I did that for, like, about four years. And then it just kind of kept growing from there. And then came the rise of alternative media. And I was smart enough to jump on that with Twitter and YouTube and the like. And yes, now I'm ubiquitous. I'm kind of everywhere at the same time.

B (5:42)

So just a couple of these questions before we head into a discussion about markets. Jim, what was that like for you back then? Because, like I said, everybody now is like, anyone can have a voice now. Anyone can have a Twitter account. People thread all the time on Twitter. It's so easy to get on a podcast. There are all sorts of podcasts you can get on. But you were doing media back when there was a real barrier to entry and only so many people could do it.

A (6:08)

What was that like being on TV at that time?

B (6:10)

Was it cool for your parents?

C (6:13)

Yeah, no, it was cool. It was cool for my parents. It was cool for me. Fortunately, in my case, I'm in Chicago. I was in the Loop at the time. And it was easy because all the networks, they had Chicago affiliates and. Or there was a couple of independent studios that were all within a block of my office. So it was really easy to walk over there and just do it and stuff. But it was. And the old joke I used to say is to people is, of course, I know what I'm talking about. I'm on television. And that was kind of the joke. Now, today, with the rise of social media and stuff like that, that doesn't mean anything. But back then, it did. So that people would look at you and go, oh, he was on tv. And I always used to have this joke. I used to say, people would say, oh, I saw you on tv. And I'd always ask them, well, what did I say? And they'd go, I liked your tie, is basically what they'd say. They'd never, ever remembered what you said. But if you were wearing a funny tie or your hair wasn't combed right, they'd always remember that.

B (7:13)

Yeah. And you learn very quickly that what works in person is not the same thing that works on television. And you have to be more exaggerated on television across the board. And I still think that there's something special about being on a TV set that's very different from being behind a zoom camera. So, all right, that was just me indulging a little bit in some personal questions for you, Jim.

C (7:31)

Yeah, just real quick on that last part. I agree with you that being in the studio or being on a live set, it's very, very different. As far as zoom goes, I like to say it's better than not zoom, but that's about us.

B (7:43)

It's more convenient, but it's a totally different experience being on live television and live television especially. It's exciting and it really feels like you did something with your time.

A (7:53)

So as I said, Jim, I'm going.

B (7:54)

To ask you a lot of questions that are informed really about what you've been writing and talking about, not just recently, but for several years now. Because you and I actually the last time I think we were in the same room together was at a Simplify Asset Management panel that I moderated at the nyse. And we'll talk about that because you had some relevant views there.

A (8:12)

Let's just talk a little bit about.

B (8:13)

What'S going on today in the bond market and how that has or has not been informed by the Fed. Because the Fed began what seemed like a fairly aggressive rate cutting cycle in mid September by opting for 50 basis points and they followed that up with two more rate cuts of 25 basis points each in November and December, which brought the target interest rate range to 4.25% to 4.5% for 100 basis points in total cuts over a roughly three month period. So a short period of time. At the last FOMC press conference, Powell adjusted his remarks to caution against the expectations of too many more Fed cuts, stating that we're closer to the neutral rate. The dot plot was also revised upwards, suggesting a revised estimate by some FOMC members about the need for more future cuts. How have markets reacted since that last meeting and what are they pricing in in terms of future Fed cuts?

C (9:09)

So the way the markets have been reacting has been fairly unusual. If you go all the way back to the September meeting when they cut 50 basis points, long term yields, the 10 year yield, the 30 year yield, mortgage rates have been going up. They've gone up over a full percentage point. That is very rare to see in the middle of a rate cutting cycle where the Fed is lowering its short term funds rate to see long term yields being rising at the same time. I've looked at it all the way back to the early 1960s and the only comparable example I can find was 1981 was when the funds rate was at 20% and Paul Volcker cut that rate down from 20% to 16%. Remember, this was the 80s and this was very different interest rates and the bond market didn't like it. At the time, the 10 year yield was at 12%. It went up to over 15% while Volcker was cutting those rates in kind of the spring and summer of 81. I think really what it's telling us is that the market doesn't like the policy, it doesn't think that the policy is appropriate and it might be fueling a latent fear of the economy overheating. What does it mean that an economy overheats is inflation. Is that if you're going to give us all this stimulus and the economy doesn't need extra stimulus, it will just show up in the form of people bidding up prices in higher prices, otherwise known as inflation. Now, since the last meeting, as you've been asking, rates have continued to move higher on this same idea. Now, there's a bit of a divergence here. What is the expectation for the Fed? Well, there's two ways you can measure it. You can measure it by looking at what the market is pricing, what the market expectation is. And that is that there's maybe one more rate cut this year. Some measures have it at no more rate cuts this year. And then you can measure it by looking at the headlines in the speeches that Federal Reserve officials have been giving. And they keep talking about rate cuts this year, that just last week there were six different Fed officials and that came out and said that there will be more rate cuts with an S. Plural, more than one. Remember, for those not steeped in this, a cut is defined as a 25 basis point move. So you could do two of them in the same day like we did in September, with a 50 basis point cut. That would be considered two cuts at once. So they're talking about multiple rate cuts still for this year when the market is not thinking that way. So there's a bit of a divergence between what the Fed is saying and what the market is expecting right now.

B (11:42)

So I feel like this opens two questions. Which is one or an opportunity to stress test this argument, which is one, what is actually driving the move upward in long term yields? Is it Fed cuts or is it, for example, what would you say, for example, to someone like Richmond Fed President Tom Barkin, who was recently quoted as saying that the supply of new debt issuance is what's driving yields on the long end and not inflation?

C (12:06)

So there's a lot of factors. Bond markets like stock markets are very complicated things and there's lots of Things that can be moving them around. And so there are what I would call background factors. Big deficits means lots of supply. That can be resulting in lower bond prices, which means higher yields. The prospects of the Trump administration coming in, extending tax cuts, cutting taxes, which would in theory, I know Arthur Laffer would push back on this, but in theory lower revenues and increase the deficit even further. Deregulation, which could be very stimulative for growth and potentially tariffs, which would be another form of raising prices or another type of inflation. All of these things you could credibly argue should be pushing up interest rates. The only pushback with that is those things have been constant for a long time, especially the deficit. We were at 3.6% 10 year notes in September, the deficit was a problem. Today we're at 4.8% on the 10 year note. The deficit is still a problem. It wasn't a non problem then. So where I would come down on is okay, what changed? What was not present in September that is present now and that is Fed policy. The Fed started cutting rates with a 50 basis point move or 225 cuts at the same time. That signaled to the world that they want to get aggressive. And right after that, that 3.6% 10 year note was the low point of the year, literally the day or two before the Fed meeting and interest rates started to move higher. So what corresponded with the change of interest rates from going down into September and and up was it occurred right as the Fed gave us that 50 basis point cut in rates. That was the change on the margin. Now I would agree deficits and tariffs and stimulus and all that is why we're at 4.8 and not 3.8 or 3.2. That that's holding rates up. But the change on the margin was definitely Fed policy.

B (14:23)

So I took a quick look at the UK gilt market, but I don't know. So it looks very similar, seems to be really tracking with the US But I'm not clear on what the bank of England's monetary policy has been. So is there any way to compare what we've been seeing in terms of yields with other developed economies and their monetary policy to see if there's some independent factor that's driving both?

C (14:45)

Yeah, I mean there is in that all of the yields in the developed world and I use that word because I'm excluding China for the moment. I'll touch upon that in a second. You know those all their yields are up, they're all at multi year highs. Whether it's Japan, it's Germany, it's the UK. UK's, you know, their 30 year gilt, the 30 year bond is at something like a 28 year high in interest rates. All of these rates are moving up. In the US, our 30 year bond is less than 15 basis points or 0.15% away from a new 17 or 18 year high. So we're not that far away ourself. And what's driving all these rates I think is the prospects of higher inflation. Because if you look from Japan to the US to Europe, you've got elevated levels of inflation. And what I mean by elevated levels of inflation, if you look at the level of inflation in the developed world today and compare it to the decade before COVID so 2010 to 2020, these are levels that would have been completely unacceptable for inflation five years ago during the 2000s. Yet we've seen this level of elevated inflation around the world. So I would argue two things that are happening. One is the cycle on inflation. The disinflation cycle ended in 2020 and it's now turned to be more elevated. Second of all, a lot of sovereign bonds are bought by international managers. They're all somewhat interrelated to each other. And especially given that Europe now has one central bank for 17 countries. There's another stress point that's starting to heat up in Europe and that could be best described with what's happening in Germany. The German economy is not in a good place right now. It is really struggling in a big way. Why is it struggling? Germany has been the manufacturing base of Europe for decades. To be a manufacturing base or be a manufacturing success, you need one of two things. You either need cheap labor. And cheap labor could also be defined as being uber productive. You might be paying people living salaries in developed worlds, but they are so productive for technology that their unit cost makes it very cheap. Or you need cheap energy. And in the case of Germany, they had cheap energy in the form of cheap natural gas from Russia. And it just kept flowing into the country kind of without end. And then the Ukraine war came, the gas spigots from Russia got shut off, the price of gas went up. And all of a sudden their manufacturing base has seen its raw material inputs and its energy inputs go up a lot. And it's really made them uncompetitive and it's really hurting their economy. What their economy could use is much lower interest rates. But they're suffering with the uk, with France, with the US that all these interest rates are going up. Their interest Rates really can't go down. Now what's compounding it is they've all got one central bank, the European Central Bank. It's no longer the Bundes bank and the bank of France or the bank of England because they're not part of the Eurozone, still exists, but they can't run an independent policy. So they're stuck with these higher interest rates and it's really hurting them. And so yes, this is the problem with sovereign bond markets and with the modern world. We talk about synchronized growth in an era when we don't have synchronized growth. And then finally the other one I'll point out just real quick is China. Interest rates in China are at an all time low. They're bucking the trend and they're going straight down while everybody else's interest rates are going up. What's happening in China is kind of the same type of thing. Their economy's in a horrific place right now. Chinese report a gross domestic product number. Yeah, it's reported by a communist government. Yeah, you should take that with a grain of salt, but compare it to itself. They're reporting that their GDP levels are about 4.8 or under 5%. Now remember, this is China, so 5% there doesn't mean the same thing as 5% in the rest of the world, but 5% in the last 50 years there's only been two times that it's been weaker than 5%. The COVID shutdowns and Tiananmen Square in 1989. So this is other than those two specific examples. This is about the lowest growth level that we've seen in China in 50 years. And with their bond market interest rates plunging to all time lows, that's a market signal that their economy is in a world of hurt as well.

B (19:26)

So we'll definitely have a chance to talk about China. I'm really glad you brought up Germany because the German economy is capital intensive, they have a lot of industry and that tracks well with our understanding of the impact of interest rates on inflation. Traditionally, the way we think about the effect that the interest rate channel has on inflation is that it depresses borrowing by consumers and businesses and therefore lowers economic growth, which lowers inflation. What would you say to someone like Warren Mosler and others who have consistently argued that higher interest rates are stimulative because they increase interest bearing income for savers more than the depressed borrowing for consumers and businesses, and that that's more operative here in the United States? And so that when the Fed is actually lowering interest rate, it's actually creating tighter economic conditions versus raising them and actually putting money into people's pockets.

C (20:12)

He's right in that the mechanics of what he says is correct. You know, I like to use the example of Boca Raton, right, With all the retirees. Now, from 2010 to 2020, as a retiree in Boca Raton, you didn't have a whole lot of options with your money because all of the interest rate options that were available to you were down, in the case of a money market fund, at around zero. So you weren't earning much interest income at all, especially relative to even a 2% inflation world. And the only way you could probably make extra income as a retiree at that point was to take a risk, or maybe you might even consider it excess risk by, you know, investing in stocks or investing in something that's a little riskier. Of course, it could, you know, return you well, which stocks wound up ultimately doing during the decade. But you could also risk decline. And now today, a money market fund is yielding you in the low 4% range. Bond funds can yield you as up to close to 6%, and those are well above the inflation rate. So you've got low risk options in order to do more with your money, and you're generating interest income. So he's correct in that the pushback I would give you is, while that is technically correct, I don't think it's big enough to drive the entire economy that the amount of interest income thrown off to the bulk of retirees or anybody else that owns bonds or any kind of fixed income investment that generates an income is enough that you're going to see it in the retail sales numbers. You're going to see it in the consumption numbers. Oh, higher interest rates. Look at those consumption numbers going up. Because people are getting bigger monthly checks from their bonded or fixed income investments, and they're running down to the mall and spending it. I don't think it's big enough to do that. It's probably big enough to impact the bulker economy, but I don't think it's big enough to impact the United States economy.

B (22:05)

Well, let's not try to decide how big of an impact it's having, but let's just say it's having some kind of impact. And is whatever impact it's having become diminished once people who have locked in rates at the pandemic level of before begin to have to refinance, whether they're mortgages or some other kind of loan they've taken out? In other words, who's tracking that. And do we have a sense of when and how much money is going to start to get rolled over at higher interest rates going forward?

C (22:32)

Yes, you're right. So the offset to that, of course, is that while older people that don't have a lot of debt and have a lot of wealth can get higher interest income, younger people that need to borrow to buy a car, to buy a home, new startup businesses that might want to borrow to expand, they have to pay higher interest rates. So I think when you net the two together, higher interest rates are probably a net drag on the economy. Now, to your question about, you know, mortgage rates and the like and seeing that we're going to see a rollover. Yes, you know, the Mortgage Bankers association and some others do some statistics on this stuff. But I don't think that the problem with the mortgage market is that there's all these mortgages that are going to eventually have to roll over. That's more of a problem in the corporate bond market. That's more of a problem maybe with the US Government because of its borrowings, that they're going to have to see these lower interest rates that they took out three or four years ago mature, and then they're going to have to, you know, reborrow at higher rates. I think the problem with the mortgage market is everybody's trapped. You know, they refinanced their house all the way down to 3% mortgages. And so they're sitting in their house at a 3% mortgage. That's fine. I like my house. My monthly payment is fine. But if I want to move for whatever reason, a lifestyle choice or a business opportunity, now I have to give up my 3% mortgage and I have to go get another mortgage. And that's probably going to be above 7. And that means that my monthly costs are going to be much higher than they are right now for the same type of house, a higher monthly payment. So therefore, I elect not to move, pass up that business opportunity, pass up moving to a different neighborhood or potentially looking at a different school system or lifestyle change. And so what you've seen happen is the amount of housing transactions in the economy is down by a third. Maybe it's 40%. One of the fixes we could have to that is, in some European countries, they have assignable mortgages. In other words, if I have a 3% mortgage on $300,000 left on a 3% mortgage, I could take that mortgage and assign it to a different house and just keep paying that 3% on my next house. But we don't have that kind of scheme here in the United States.

B (24:48)

Do you think we might get that? I'm really glad you brought that up because that's something that I've thought about. And I've also wondered whether a real estate friendly person like Donald Trump might push or something like that. Do we have any hints that that might actually come to pass in this administration?

C (25:01)

No, there's no hints on that right now, largely because I think that the Mortgage Bankers association and the rest of it, they wouldn't want it. They like the idea that we have a giant mortgage business here based on the rate, the ability for people to refinance, based on the way people getting mortgages. And the idea of an assignable mortgage means that, you know, once I get a mortgage down to 3%, I'm done and I can just start jumping around from house to house and take that mortgage with me, take that interest rate with me along the way. You know, they're going to lose out on a lot of those fees. I think what would probably help to get assignable mortgages is to make the home closing in the and the home process a lot cheaper. Look at how much it costs to close on a home, close on a mortgage. It's thousands of dollars. And so there's a lot of vested interest in keeping it that way. So I'm giving you a cynical answer to why we're not going to get it. There's too many people that got their hands in the till on the whole mortgage industry and they don't want to do something like assignable mortgages that would basically take that away from them.

B (26:08)

So one more sort of devil's advocate question here, Jim. You've argued that the Fed doesn't have a working theory of inflation. Correct.

C (26:15)

Dan Torillo is a fed governor from 2009 to 2017, gave a speech at the Brookings Institute in October of 17. I like to joke the best Fed officials to listen to are the ones that recently leave. That was right after he left the Fed. And the title of his speech was the Fed has no working theory on inflation. And I happen to wholeheartedly agree with that. Now let me quickly define that people go, wait a minute. Inflation's all about money supply. Look at M2 and it'll tell you what inflation's going to do, or it's about government spending, or it's about rational expectations, or it's about some other theory that causes inflation to go up or the level of the dollar. And his argument, I think is correct, is okay, break each one of those down, do a study of that. You'll find the correlation between inflation and those particular theories is zero. Sometimes they work, sometimes they don't. They're not stable relationships. And the conclusion was they don't have a working theory of inflation. That's fine. I don't have a working theory of inflation. The economics department at MIT and Goldman Sachs doesn't have a working theory of inflation. The difference is the Fed presents itself as if they do have a working theory of inflation and they've got these little knobs and levers within the halls of the Federal Reserve that they could twist and pull and put the inflation rate at wherever they need to put it at. That's not true. Inflation is an extraordinarily complicated thing. It is a psychological input. That's why we look at inflation expectations. It's also an economic input looking at the levels of growth and everything in money supply and all this, all of these things together in kind of a non linear way impact the levels of inflation that we get. And it's really hard to pin it down into a simple equation. So here's all the inputs, there's the output, there's what the monetary policy should be based on, where inflation is and where we expect it to go. It's not that simple.

B (28:16)

So then my question is, why should we believe that investors are raising their inflation expectations based on Fed policy when the Fed doesn't have a working theory of inflation and neither does the market?

C (28:27)

Well, yeah, that's a good question. Right, because we have all of these inputs to it, like measures, survey measures, markets that are giving us expectations of where inflation are going. The treasury has a specific treasury security called a Treasury inflation protected security. What it does is it pays you an interest rate plus the inflation rate. So, you know, if you buy the 10 year tips, as they call them, it's now yielding at around 2.3%. What does that mean? It means whatever the inflation rate is for the next year, you will get that, that plus 2.3%. So you get a real yield above inflation at 2.3%. You can use these securities in the market to measure what the market thinks future inflation would be. Now you're correct. If you do look at it historically, these are not very good indicators of where inflation is going to ultimately be. But I've likened it to, I'm a sports fan, so I've likened it to like the point spread in a football game. It's kind of useful to know, you know, in the football game whether a team is an underdog or is a favorite, and if they're a favorite by more than a touchdown or an underdog by more than a touchdown or favored by one point, that's information about the expectations of how these two teams are going to do. But once they play the game, that doesn't mean that if a team is a two point favorite that they're going to win by two points. They could win by 20, they could lose by 20 or anywhere in between. So a lot of this market stuff is informational and it's useful to say, well, the market thinks that there's going to be higher levels of inflation in the future. And to a lot of the tips and measures, I would argue that they are showing that the market expects higher levels of inflation in the future. It doesn't have a working theory, but it expects it. It's very legitimate to say yes, but the market will be wrong. And here's why. The market will be wrong, and it's been wrong plenty of times in the past. But nevertheless, that expectation is, is that we are in a period of higher inflation and we expect more inflation. Now, real quick, when I say higher inflation, I want to give a definition of what we're talking about. Prior to 2020, the inflation rate was 2% or lower. We'll call it 1.5 to 2. I think what markets are trying to tell us now is that we're looking at inflation closer to about 3ish or maybe slightly higher. Now if you're not steeped in the bond market, well, 2% to 3%. Is that a big difference? Yes, it is actually a very big difference. It's a very big difference for the bond market because it really goes to the heart of pricing in the bond market and the level of interest rates and the all across the yield curve get impacted by it. And it's a big difference for people in the economy. Bear in mind we refer to the economy as being K, shaped like the letter K. So the bottom half of income is kind of falling. They're the bottom K and the top half of income is kind of rising. Why is that? It's because of inflation. The bottom half of income. People that are in the bottom half of income typically don't own a home. They don't have a home as an asset. They rent. They usually don't have a portfolio, they don't have a lot of savings. They live paycheck to paycheck. So when prices go up and everything becomes more expensive, they just have to pay it or in some cases they have to make substitution arguments. If I want to buy this, I can't buy that. People at the top end of the income have assets and assets have performed very well over the last couple of years, whether it's been home prices which have largely held together, or stocks which have recently been at all time highs. So people at the top end of the income can, you know, go to the store, see that prices have gone up, everything's more expensive, and then they could mutter some four letter words about it, but then they could just pay it, move on with their life because their asset levels have increased and their net worth has increased. So this level of inflation going from 2% to 3%, it really matters. And look no further than the political polls during the election season. What was the number one issue was inflation and the Democrats and some of the economists, but it was a problem two years ago and it's not a problem now. Went from 9% down to 3%. But the cumulative rise is what has really bothered a lot of people. It is a big scourge on an economy. Inflation has big implications for the bond market and for the economy in general.

B (33:00)

So I think you've been consistently warning about inflation for years now that we're not out of the woods, if I recall correctly.

C (33:07)

Yes, Correct.

B (33:08)

During that panel it was moderating you, Mike Green and another person who was an economic cycle analyst who was particularly concerned about the lagging impact that the rate rises would have on the economy and therefore bringing down inflation. I think you were the one saying we're not out of the woods yet.

A (33:22)

Is there some way to.

B (33:23)

How would you articulate your concerns or views about the prospects for inflation being a headwind for this economy going forward? What is your view overall and what do you think are the primary drivers of it? Putting aside the recent Fed policy moves, what are the structural drivers, in your view, that are going to inform whether or not we have persistent inflation? And will we, in your view?

C (33:44)

Yes. So let me talk about the economy, big picture for just a second. A capitalist economy, that's what we are. Where we have the Schumpeter, creative destruction, and that is more so the case in the U.S. especially around technology, than we've seen in a lot of other countries. So in a capitalist economy that constantly reinvents itself, the natural state for that economy is to grow. And Since World War II, 90% of the years that we've had, we've been not recessionary years. What is a recession? A recession is an unexpected sharp event that shocks everybody into changing their behavior Covid. Shutting down the global economy was the last recession. Housing prices crashing and $145 crude oil in 2008 was the recession before that. Before that, the recession was affiliated with the tech bust and 911 in 2001. Before that, the last recession in 1990, 91 was around Iraq invading Kuwait and having a 400% rise in crude oil. So typically what happens is the economy grows. It might grow slower, might grow faster, but it grows. Then you have this, I'll call it an oh shit moment and everybody changes their opinion, oh, I was going to go to the store and buy stuff, but man, that's just happened. I'm not going to go to the store. You know, we shut down the stores in the case of 2020 and you couldn't go to the store. And then you have a recession and maybe you have a financial crisis. And every time you have a recession or a financial crisis, the economy fundamentally changes coming out of it. Now, I want to be clear or careful with this word that it changes. Changes is not dystopian. I didn't say it gets worse, I said it gets different. It was an apple and now it looks more like an orange. An apple or an orange. Neither one is better or worse than the other one. They're just different. So the economy changes in certain ways coming out of the 2020 shutdown. You know, Covid, I'll refer to it from the economic standpoint, the global shutdown and restarted the economy. It came back differently. The reboot, when you rebooted the economy, it's not the same. The biggest thing that we are familiar with that has changed in the economy is probably remote work. Remote work is a thing. It's here well over almost a third of the economy is now seeing jobs in some kind of a remote work capacity. Not five days a week at home, but a couple more days a week at home. Like three days in the office, two days at home. Tuesday, Thursday in the office, Monday and Friday, work from home. That's one structural change. The political winds have been another structural change. Look at 2024 with the anti incumbent wave. All of this I think comes back to that reboot of the economy. Part of that reboot I think ended the 40 year cycle of disinflation and lower inflation coming out of that. Now we are in a world of higher levels of inflation, more friction in the economy, changing tastes and preferences in the economy so that supply chains are not in sync with what we want. And all of this is leading to higher levels of persistent inflation and again, 3ish percent inflation, or as I like to joke, not 8, 10 or Zimbabwe levels of inflation. So it really starts with this idea that we have fundamentally a post Covid economy. Who by the way pushes back on that is Jay Powell. He has for years in his press conferences used the phrases we're seeing a broad normalization in the economy. We were returning to pre pandemic levels. Jay, what's been abnormal about this economy and what is it normalizing to this idea that as I like to shorthand it, we're not going back to 2019. That was the old era. This is a different cycle. And again, it's an apple, not an orange. It doesn't mean it's worse. I know when I say it's changed, everybody wants to think I just said it's worse. It's not worse, it's different. And part of that difference, I think is leading to persistent inflation that we've seen now for several years. The Fed says, I'll give you one statistic just to sum this up. The Fed says that they're still on target and still believe that they can get the inflation rate back to 2% via monetary policy. From 1996 to 2001, the core measure of CPI, that is ex food and energy, was never above 3% for 25 consecutive years. Each single month it never went above 3%. Since April of 21, we've had 45 months in a row where it's never been below 3%. And yet we keep talking about that. We're broadly normalizing, we're returning to pre pandemic levels. The inflation rate is doing nothing of the sort. It is a higher level than we've seen in the past.

B (38:38)

So I'm really glad you brought that up. Do you think that it's that he really doesn't understand that we might be in a new paradigm, or is it.

A (38:45)

That it's very challenging for him and.

B (38:47)

Other members of the FOMC to adjust their messaging to square with their own models of the world or with economic reality that in other words, they're sort of trapped by public perception about the role of the Federal Reserve, its omnipotence and the inflation target?

C (39:02)

I think it's the latter. And interestingly about the latter. When all of the cognitive decline stories came out about Biden, Jay Powell was asked about it. And Jay Powell pointed out that he's only had one face to face meeting with Biden in the four years. And that face to face meeting was a public meeting. It was In May of 2022, it was in the White House, in the Oval Office. He sat on the couch, Yellen was there, Biden was there. Biden read from a sheet of paper. And I'll, I'll paraphrase what Biden said at the time, May of 22nd, the inflation rate was 8.6%. He said, America, we got an inflation problem. Again, I'm paraphrasing what he said. And he literally pointed at Jay Powell and he said, this guy's going to make it go away. This guy's going to fix it. And ever since then, Powell has been saying, we are firmly committed to our 2% inflation target. He's kind of made this promise for years that he's going to get the inflation rate back to 2%. And it's hard for him to come out and say, okay, I know I said it 8,000 times, I get it back to 2%, but I guess I really can't do that. And so they're afraid about the Fed's reputation, they're afraid about their credibility that they've made this promise. Now the Fed has what they refer to as a framework review. Every five years, communist parties and the Federal Reserve have five year reviews. And this is coming up in 2025. The framework review is kind of what the word implies, that they look at a bigger picture view of what they're trying to do. Maybe they change their inflation target coming out of the framework review. We won't probably know until the end of this year or early part of next year if they indeed do that. But yes, I think that in the interim, I don't think the market really believes that we're going back to 2%. The Fed keeps saying it. I think a lot of economists and a lot of market people like me have said, look, we're not going to go back there. But as long as he keeps saying that, he being Jay Powell, and as long as he keeps making that commitment, he says, we're here to serve the American people. And then he says that that means we have to get the inflation rate back to 2%. He's made a promise that I don't think that they can currently fulfill in this cycle.

B (41:13)

So is there a difference between the official inflation target and what the Fed is actually targeting?

C (41:19)

There might be, but there's no evidence, at least at this point, that there is.

B (41:23)

Well, the fact that they're cutting interest rates when they're not back to target isn't that inconsistent with what they've been saying publicly for the last several years.

C (41:30)

Other than that they say that they're cutting interest rates and they're not back to the inflation's back to its target, but they're saying that it's on its way back to the right.

B (41:38)

They're relying more on forward looking data as opposed to concurrent or lagging indicators.

C (41:43)

Exactly. But they continue to say that they will eventually achieve that target and that they're so confident that they can achieve that target that they're lowering interest rates. And again, I'll emphasize, but the bond market is not buying it because yields are going up. So you read, oh, the Fed's cutting rates. And everybody says that means mortgage rates are going to come down. Yet they're going up because during the period that they've been cutting rates.

B (42:07)

Grant's deputy editor, you mentioned Jim Grant earlier. Grant's deputy editor Evan Lorenz recently tweeted that the rate cuts will continue until morale improves. Speaking of communist frameworks and the Fed.

C (42:20)

Yeah, exactly. There is that school of thought among some market watchers and economists that, no, the problem is the Fed's not aggressive enough in cutting interest rates. If they were to be more aggressive in cutting interest rates, then long term yields would fall. The only retort I would give to that is that's exactly what they did in September by cutting 50 basis points, two 25s. And the response was that was the low of the year and interest rates started up off of the aggressive move and haven't looked back since. The other problem, the Fed has too. Claudia. Sam, an economist used to work at the Fed, gave me a great line that the Fed is not partisan, but they are political. And I think that's correct. Not partisan. They don't sit around the FOMC table during the meeting going, you know, let's call it what it is. We don't like Donald Trump. We don't really want him to be president. So what can we do to sabotage his campaign? They do not do that. But they are political. They are concerned with how they're perceived. And one of the things that they've also kind of trapped themselves into Is they cut seven weeks before the election by 50 basis points. They cut two days after the election, they cut in December, and now they're talking about slowing down. And Donald Trump has been criticizing the Fed that you're cutting interest rates ahead of the election and promising immediately, two days after the election there'd be more cuts to try and help my opponent by lowering interest rates. And then when I become president, you're going to stop cutting interest rates. Trump's timeline is Correct. They were cutting interest rates before the election and he doesn't become president until January 20th. And it looks like they're going to stop right after January 20th. And so politically this looks terrible for the Fed that it makes them look that partisan role that I don't think that they are and that they are going to have to kind of deal with that problem as well too. And some have argued that that might lead to a further mistake. Well, maybe we ought to cut rates in the spring, you know, just so that we don't look partisan, so that we look like, you know, we'll do it regardless of who the President is. Well, if you're making a mistake now, you're just compounding it for political purposes. Just because I said they might do that doesn't mean that they will. But, but the point is that people, I'm sympathetic to this too, are starting to think that way about the Fed.

B (44:40)

Yeah, it's going to be reality TV season two now heading into the second Trump term.

C (44:45)

So we'll have to get in ways we don't know.

B (44:47)

Yeah, ways to get used to that again. So I do want to talk about stocks versus bonds, 6040 correlations versus anti correlation and what the right portfolio mix should be to protect investors in this new regime. But before we get into that, just a few more questions. One of them has to do with US Economic growth. Again, to go back to that simplified panel, that was about 18 months ago. Since then, the US economy has had very strong economic growth and it's outperformed other major economies in Europe and Asia. What explains that in your view?

C (45:20)

I think the old line that the US innovates in Europe regulates really comes in the fold. I think one of the things that the US economy has that other economies don't is its creative, destructive, flexible nature. And I mentioned that before about creative destruction and its innovation. So if you throw into the idea that we had the shutdown restart of the economy and we needed to be a little bit more flexible to restructure into a post Covid economy, the US Economy has been able to do that faster and more efficiently than a lot of other economies and then you throw in the great growth hope, maybe eventually reality is artificial intelligence and AI is largely being born out of what's happening in the US and especially in Silicon Valley. Less so there isn't really a whole lot of AI innovators in Europe and there isn't any really a whole AI innovators in Japan. And maybe there's AI copycats in China, but they're not really leading on that. So we're able to remake our economy quickly, and we're able to do that in ways that others don't. And we've got the great new economic engine of coming of the potential of artificial intelligence. And it's going to be led by the US Economy. You add it all up and the US Economy is doing much better. It also doesn't suffer from some of the constraints that other economies suffer from. As you know, we talked about, Germany is the economic engine of Europe. It is suffering because of higher energy costs. We don't really have that problem in the U.S. china, which was perceived to be an economic engine, is suffering from years, if not decades, of malinvestment in property. And they've got a bunch of bad property that's hampering their banks. We had that problem in 2008. We kind of got past that problem fairly quickly. It was painful, but we did it. China hasn't done that. So we don't have these structural impediments to the US Economy growing much faster either. So that's why I think that for now, the US Economy has been kind of head and shoulders above everybody else.

B (47:27)

So I've heard you say this before, that there's not going to be a recession until you see a murder weapon. What do you mean? And what would qualify as a murder weapon in this context?

C (47:36)

So that's a statement from Rudy Dornbush. He was an economist in the 1970s at MIT and the exact statement was economic expansions don't die of old age. They're murdered. And a murder weapon is a Covid shutdown. A murder weapon is invading an oil country and watching a 400% rise in oil. Something that happens, and people say, whoa, whoa, whoa, everything just changed. And that that's what causes a recession. And I like to joke that the last person you should ask whether or not we're going to have a recession is an economist. And I don't mean that to slight economists. They could tell you the economy's going to slow down. They could tell you the economy is going to speed up. But the natural state of the economy, as I mentioned earlier, is to grow. But are we going to have that exogenous event that's going to cause a change, an instant change of behavior that causes the economy to slump in the recession? Those come from outside the economic circles. Now, to give you an idea, the last thing that I think we saw that could have been a murder weapon for the economy was the failure of a bunch of banks Led by Silicon Valley bank In March of 2023, we had Silicon Valley bank signature Bank, Silvergate bank fail. Soon followed by Credit Suisse in Europe and then a month later by Republic Bank. So five big banks within a matter of a couple of weeks, all failed. Were we having a contagion in a banking crisis? Boy, for a moment there In March of 23, it looked like that's exactly what we were having. Financial markets were responding by stocks were plunging, interest rates were plunging. They were responding as if we were having a crisis. And I remember saying, using that thought, you wrote something called is this the murder weapon? And at the time I was giving it a 50, 50 chance, if not better than a 50% chance, that it could have been something that could have altered everybody's behavior, altered regulators behavior, altered banking behavior that could have pushed the US economy in the recession. For one reason or another, that did not happen. But those are the types of things. I point that out because that's what you look for, whether or not you'd have a recession, a contraction in the economy. An economist can tell you that the economic data might lead to a vulnerability so that one of these murder weapons could actually do damage or an infincibility that we could like maybe that's what happened in 23, is that the economy was so strong and recovering so hard from COVID that even a rash of big bank failures like that couldn't kill it. You know, they could tell you that, but they can't tell you if we're going to have one of those events. We don't know when or where or how those events are going to come about. But those are the things that, you know would murder an economy and cause a recession.

B (50:25)

So could Trump's tariff policy be one such murder weapon? Because the Chinese now running, I think record current account surpluses around $1 trillion with the rest of the world. A third of that is with the United states. And the U.S. itself runs a trade deficit, I think of roughly $80 billion or so, kind of near its all time highs. So significant tariffs could be very economically disruptive. Could that send the US and the world into a deeper recession?

C (50:52)

Sure. I mean, that's always a risk, you know, to just give you more of a local example with Canada, you know, Trump has suggested that, you know, he's going to put on universal tariffs and might put on 25% tariffs against Canada the day of the inauguration. Okay, maybe he does that, maybe he doesn't do that. And then the Premier of Ontario, Doug Ford has said, look, you guys get a lot of electricity and. And a lot of power from Ontario. We're going to shut that off. You give us 25% tariffs, then we're going to put a lot of people in the Northeast in the dark. He literally said that. There you go. That's a big murder weapon if that scenario unfolds. So there's always that risk that it's going to be something like that. But typically, those murder weapons are usually things that you don't expect that would come about that would murder an economy. You know, the big murder weapon in the 1974 recession was probably the second worst since the Depression, the worst being the financial crisis of 2008 or maybe even Covid, if you want to throw that in, though, that was such a unique recession that had gas lines. I'm old enough to remember when I was a little kid, you know, whether or not our license plate was odd or even, and the days we could. You could go with my mom and sit in line for an hour, 12 cars or 15 cars deep to get 10 gallons of gas. You know, that was the Arab oil embargo and the Yom Kippur War was.

B (52:24)

Right. The murder weapon.

C (52:25)

Right. And that was a murder weapon for the economy. So the reason I bring that up is typically these are the types of things. So, yes, if the tariffs are used in that form and there is retaliation from the tariffs, yeah, that could absolutely be one that said, count me in the camp, that I think we're overstating the tariffs of risk. In other words, read the art of the deal. It's a gambit. It's a negotiating tool. I'm going to hit you on the head with this bat called a tariff, unless you do something. And everywhere you hear Trump say this, he says, do A, B and C or I'm going to hit you on the head with tariffs. All right, we'll sit down, let's talk about A, B, and C, and let's come to an agreement. And then you'll do small tariffs that we could tolerate or no tariffs at all. So I tend to think that they're more of a gambit than an actual weapon that he intends to employ. Well, but he says it's the most beautiful word in the dictionary. And everything else. Well, yeah, you know, read the art of the deal. If you want your negotiating tool to be credible, you have to act like it's credible. And that's exactly what he's been doing with tariffs.

B (53:33)

I suppose the relevant question for me would be, and I don't know how to answer this question. Maybe people that know Trump would be able to answer it. But the relevant question is is he looking for a deal that looks aesthetically good, or is he looking for a deal that will actually lead to real substantive change in terms of rebalancing terms of trade and re industrializing the United States and bringing back some of these lost industries or rebuilding sectors of the economy that are necessary for building resiliency? If that's his actual goal, then I think there is much more risk that the tariffs could induce an economic recession than the latter, which would just be a sort of a photo op and some nice speeches and him and Xi Jinping together holding hands, which is what I felt like the last administration was. I didn't feel like there really was enough meat or effort behind really using those tariffs to achieve some of the objectives that he stated. So I'm going to move us to the second hour. Jim and I mentioned that I want to talk about one the impact that the rising rates on the long end of the bond market have or could have on the stock market and on the proposition that investors should hold the percentage of equities that they currently have in their portfolios. I think actually people nearing retirement are somewhere like 80% of their portfolios in equities, some record number. I want to talk about that. I also want to talk about that in the context of the 6040 portfolio and the anti correlative effect that stocks have had with bonds in recent decades. Now, historically, these two asset classes have spent more time trading in tandem than they have trading separately. 2022 was an especially bad year for that portfolio. One of the things I want to talk about also is what does a proper portfolio mix look like for investors that are trying to achieve some of those properties? We'll talk a little bit more about the Chinese economy. I want to ask you a question about gold and then also one more about US Equity and indexation concentration, which goes back to this conversation about the stock market and equities.

A (55:28)

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B (55:30)

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A (55:52)

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B (55:54)

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A (56:06)

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B (56:21)

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A (56:24)

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B (56:43)

We'll see you next time.