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Danielle DiMartino Booth – Global Macro Series – 29th July 2020

Our guest today is Danielle DiMartino Booth, CEO and chief strategist for Quill intelligence. One of the major themes of our podcast series so far has been the reactions of central banks to the global pandemic, and it’s likely effects on inflation and asset prices. As a former Fed insider, with nine years of experience as an advisor to the president of the Dallas Fed, Danielle is uniquely positioned to give us her take on the action taken by central banks so far, and what their next move is likely to be. However, our conversation was not just about the Fed, as it covered many other interesting topics including the curious timing of the US-China trade talks and when we first learned about COVID in the autumn of 2019 (one for conspiracy theorists!).

Topics Discussed in this Episode

  • COVID-19
  • QE and the transmission mechanism
  • China

“The number of people moving from Chinese Suburbs, urbanization if you will, a massive, massive secular trend, was coming to an end… You pile the trade war into this preexisting dynamic, in 2019, and you end up with the global economy headed for recession. At the same time, you had leverage, of course, in a very, very bad place.”

  • US bond market
  • Monetary policy rules and the choice of inflation measure
  • Democracy: Revolution or direct democracy?

“Janet Yellen and Ben Bernanke were fighting, and fighting, and fighting for this two percent target for years but it wasn’t until Alan Greenspan left the Fed that they were able to actually implement it.”

  • China-US trade
  • Inequality

“The Fed is doing a lot for the top 1%. The Fed is helping private equity not get buried in some very bad investments that they have made. They’re helping the wealthy stay wealthier.”

  • Negative interest rates

“The one thing that I will give J. Powell credit for is holding the line on negative interest rates. It’s clear from listening to everybody on the committee and every district president that there is unity and a cohesive solid front against negative interest rates”

  • Bitcoin and ‘Fedcoin’

Links

Catch up with Danielle and learn more about her work:

Quill Intelligence


Follow Niels, Moritz, & Rob on Twitter:

Niels Kaastrup-Larsen
Moritz Seibert
Rob Carver

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Full Transcript

The following is a full detailed transcript of this conversion. Subscribe to the podcast to get access to all of our transcripts as eBook downloads!

Niels

Do they really believe that they’re doing the right thing or is it just…?

Danielle

They really. No, no, they really do. There are occasional voices of reason. J. Powell was one of them. He read my markets briefings that got under the skin of Bill Dudley and Timothy Geithner. They hated the work that I did for Fischer all those years ago but Powell didn’t, he appreciated it. In October 2012 he’d only been on the Federal Reserve Board for two or three months, at that point. It was one of his first FOMC meetings and he said that the Federal Reserve’s policy of quantitative easing was inflating a duration bubble across the entire credit spectrum, and that quantitative easing could become habit-forming, and that if and when the time came to try and extricate themselves and normalize interest rates he was in the driver’s seat trying to do that and to shrink the size of the Fed’s balance sheet, that it could be problematic.

Well, he discovered what problematic was when the U.S. high yield bond market shut down for a record forty-one days between November the 14th on, which caused all the world regulators, the VIS, everybody collateral backing, all of these ETFs were trading ‘by appointment only’ spreads gapped out, redemptions went through the roof and then we had the Powell Pivot. So, he understood what the Fed was creating – the monster that the Fed was creating, when he was a rookie at the Fed, back in 2012.

For me, the best part of my podcast journey has been a chance to refine my own investment framework through a series of conversations with extraordinary investors in every corner of the world. In this series, I, along with my co-hosts Robert Carver and Moritz Seibert want to continue our education by digging deeper into the minds of some of the thought leaders when it comes to how the world economy and global markets really work to try and learn how they think.

We want to understand the experiences that have shaped them, the processes they follow, and the historical events that have influenced them. We also want to ask questions outside of our normal rules-based playground. We’re not looking for trade ideas or random guesses about an unknown future, but rather knowledge accumulated over the course of decades in the markets to try and make us better-informed investors and we want to share those conversations with you.

Introduction

Our very special guest today is a true Fed insider who always delivers deep, broad, unconventional thinking and who connects the influences of global central bank policy, liquidity flows, and economic data into actionable investment strategies. So, I’m sure you will love our conversation with Danielle DiMartino Booth of Quill Intelligence.

Danielle, thanks so much for joining us, today, for a conversation as part of our miniseries into the world of Global Macro where we relax our usual systematic or rules-based framework to provide you with a broader context as to where we are in the global and historical framework and, perhaps, discover some of the trends that may occur in the global markets in the next few months or even years and, ultimately, how this will impact us, as investors, and how we should best prepare our portfolios.

So, we are really excited to dive into many different topics in the next hour or so, not least because you have a very special gift of taking the complexity of economics and making it concise and understandable with lots of humor. On top of this, you are very generous when it comes to sharing your views and analysis on Twitter and other platforms. So, welcome.

Let me kick off with a 30,000-foot question that we ask all of our guests in this series. It’s just to get a little bit of context for the conversation. It’s kind of where you think we are in a really big global macro picture, A lot of what is going on right now feels like things that we have seen before. There have, obviously, been a lot of analogies made to previous bubbles and so on and so forth. On top of that, we also have a global pandemic and it makes it all quite an interesting time to be in our business. So, let me just ask you where you think we are in a really big picture right now?

Danielle

So, I think what people need to realize is that China slowing to a three-decade low rate of growth, coming into 2020, prior to the pandemic hitting the global economy, was a big story in and of itself. We get great data out of the Netherlands with a big lag on global trade but we actually had year over year contraction in global trade in 2019 for a full year.

If you look back at prior recessions you have to go back to the one in 1980 and you have to go back to the one in 2007, 2009 – the Great Financial Crisis. There were actually shallow recessions in the United States in ’90, in ’01, when global trade did not contract.

That, I think, is a key component for people to grasp: the global economy was headed into recession coming into 2020. The number of people moving from Chinese Suburbs, urbanization if you will, a massive, massive secular trend, was coming to an end. This was having a dramatic impact on the German economy, the world’s third-largest exporter, and as well as knock-on effects in the United States.

You pile the trade war into this preexisting dynamic, in 2019, and you end up with the global economy headed for recession. At the same time, you had leverage, of course, in a very, very bad place.

On February 21st, just as we were hearing about the first Covid cases in the United States, corporate debt in the United States passed the ten trillion dollar mark. It had doubled in very slow order, whereas the overabundance of leverage was piled onto the household sector leading up to the financial crisis. This time it was in the corporate sector, which I think is clearly very well known given the default rates that we have seen unfold in record speed.

So, my highpoint view is that we were already headed there at a glacially slow pace and the Federal Reserve’s ‘Not QE’ at the time, growing its balance sheet, was keeping financial markets in check and then Covid happened. Now we have 30.6 million Americans collecting unemployment insurance, in some form, whether it’s through the Cares Act pandemic emergency type of unemployment claims or typical State unemployment claims, you have 30.6 million Americans collecting unemployment.

That is not filing. Filing was 47 million. We have had millions fall through the cracks in terms of filing for unemployment insurance and receiving it. That 30.6 million today represents an 18.6% unemployment rate. We’re well past anything in the post-war period. What’s critical to know is that a few weeks ago we reached a peak of 30.9 million Americans collecting unemployment insurance. So, it baffles me that there is even fanciful discussion, in the financial community, about a V-shaped recovery or a U-shaped recovery. I’m going to be writing about it today for tomorrow. We’re in a bathtub-shaped recovery right now. We have had four hundred thousand people fall off of unemployment claims. That’s it, that’s a rounding error. So, we’re in the midst of a deep, deep recession.

Niels

Yeah, it certainly is interesting times. You know, we had Jim Bianco on this series, as well, and he was talking about how the authorities seem to have this view that as long as they can keep the stock markets going up, and that’s where you have had the V, then the economy will follow. Of course, you being a former Fed insider, let’s just kick off with the Fed and what it’s doing and the responses. There is so much to unpack, so, I’ll let you decide where you want to start.

Danielle

Well, unfortunately, there are no models that you can use right now, whether you’re inside the Fed or whether you’re inside a sell-side or buy-side firm. Models need not apply. You can’t seasonally adjust anything and compare it to what has happened to the U.S. or the global economy, for that matter. But, the Fed is still relying on its models which dictate that the wealth effect will trickle down into higher lending with lower borrowing costs.

Mayor Daily, of San Francisco, yesterday, said that the Fed was not widening the inequality divide in America and that as long as they kept interest rates low, and did everything that they could, that it would eventually trickle through to households and corporations. Well, the last I checked, it’s not even trickling through properly.

The transmission mechanism is completely stuck to mortgage rates. We’ve seen stubbornly high spreads on the conventional side; forget about jumbo; major banks have completely exited the business along with home equity lines of credit. So, theoretically, you’ve got a bunch of wealth in American homes that can’t even be tapped right now.

So, the transmission mechanism at the Fed is broken and yet they’re relying on models that tell them that they are not broken. So, they keep trying to give the patient more and more of the same medicine. The only thing that it’s doing is keeping Zombie companies, now we’ve got… Jim is a good friend. He’s done great work. We kind of came into this with 14% now we’re pushing 20% of firms that are Zombies and that’s the only thing the Fed is doing right now. They’re just creating more and more Zombie firms. Carnival Cruise Corporation had its second downgrade. It’s yet another fallen angel, but it’s post-March 22nd so, it’s technically eligible for the Fed’s programs.

So, the Fed is doing a lot for the top 1%. The Fed is helping private equity not get buried in some very bad investments that they have made. They’re helping the wealthy stay wealthier. All of the things that we talk about that are not societal in nature anymore. The inequality divide has manifested and become something very economical. Again, if the Fed is not even going to recognize that they’re complicit in widening the inequality divide, you don’t even get off the starting gate.

Niels

Of course, I think they say that the definition of insanity is doing the same thing over and over and expecting a different outcome. That seems to be… Do you really think that inside, when they have their meetings, they believe their own kind of, can I say, their own actions? Do they really believe that they are doing the right thing?

Danielle

Yes, they really do.

Niels

OK, they really do, OK.

Danielle

No, no, they really do. There are occasional voices of reason. J. Powell was one of them. He read my markets briefings that got under the skin of Bill Dudley and Timothy Geithner. They hated the work that I did for Fischer all those years ago but Powell didn’t, he appreciated it. In October 2012 he’d only been on the Federal Reserve Board for two or three months, at that point. It was one of his first FOMC meetings and he said that the Federal Reserve’s policy of quantitative easing was inflating a duration bubble across the entire credit spectrum, and that quantitative easing could become habit-forming, and that if and when the time came to try and extricate themselves and normalize interest rates he was in the driver’s seat trying to do that and to shrink the size of the Fed’s balance sheet, that it could be problematic.

Well, he discovered what problematic was when the U.S. high yield bond market shut down for a record forty-one days between November 14th on, which caused all the world regulators, the VIS, everybody, collateral backing, all of these ETFs were trading ‘by appointment only’, spreads gapped out, redemptions went through the roof and then we had the Powell Pivot. So, he understood what the Fed was creating – the monster that the Fed was creating, when he was a rookie at the Fed, back in 2012.

Niels

Before (Rob) you join in, I just had another question relating to that and that is do you really think they have a choice? I know we, right now, feel that they are doing things that we would not think is the right thing to do, but I wonder if they really have a true choice of doing something different.

Danielle

No, I think that J. Powell understands. If you were to say, “J. Powell, what’s a Landesbank?” He would have an answer. He would be able to tell you that that was the first place that systemic risk popped up in the subprime crisis. I never heard of a Landesbank; I had no idea what it was. I had to look it up: small German real estate banks. How interesting and novel but there it was.

What he discovered, when the bond market shut down for forty-one days, was that he had no idea where systemic risk was going to pop up. I think that he’s realizing that now – the interconnectivity of the global financial system; the reliance on dollar funding; the explosion of the corporate debt market and the emerging markets. These are things that the BIS, the Fed, that no central bank has ever had to contend with, and the black box of God knows what in the Chinese bond market. But, we do know that there are interrelationships and that systemic risk is grounded in the U.S. corporate bond market. He knows that as long as he keeps the move index under wraps. That is he could care less about the VIX, all he’s watching is move, that’s it, every day.

Rob

I think I’ll let Moritz discuss Landesbank a bit further if he wants to as that’s his geographical specialty. (Laughter) I’d certainly like to talk about inequality a bit more latter because that’s something that I don’t think gets talked about enough.

Just sticking with the theme, that Moritz was talking about, about how well the Fed is doing, one thing that I found striking, this time, compared to 2008 is that the VIX reached new levels, the mid to high 80s, VIX spot, but if you look at the high yield spread over treasuries, I think last time around it got to about 20% and this time around I think it hit about 9% and now it’s down to about 6%.

So, at least from that perspective, you could argue that it is having some effect – I mean the transmission mechanism is not working but it’s better than doing nothing, right? I think we can agree on that.

Danielle

It is better than doing nothing but I do believe that buying high yield bonds was a mistake.

Rob

OK, please expand on that.

Danielle

Well, what you’re watching right now is the Fed fighting credit rating agencies. There is a real live battle going on. In the same exact week in time, we’ve had record defaults, record bankruptcies, and record high yield bond issuance. That means that, literally, the arbiters of credit, right now, are losing in their battle to the Fed because the Fed keeps feeding junk bonds liquidity which is buying them yet another day.

You can give a company as much leverage as you want but you cannot print cash flow for that company. We’re looking at Q2 as being down 11% plus, on the top line revenue for the S&P 500. These are indisputable, undeniable facts and two of my mantras that run around on Twitter, “You can’t print jobs and you can’t print cash flow.” But the Fed is trying to make sure that they keep the other side. It’s a candle that is burning at both ends and the Fed has completely succeeded in bringing spreads back in.

If you look at the aggregate borrowing rate across the entire corporate spectrum, you’re pushing 2%. These are all-time low borrowing yields that companies are able to take advantage of. By the same exact token, he’s not stopping the bankruptcies and he’s not going to stop the bankruptcies. So, you’ve got compressed spreads and high default rates. They’re going to have to go back to business schools and rewrite everything.

Moritz

I just want to make one point, and you just brought that up, so this is very spontaneous. You said that the people at the Fed, they really believe in their models. My question is, why is that?

I think Rob and I, we study economics but, as far as I’m concerned, not all of that is pointless. To a certain extent, it’s like this fantasy science where, yeah, you have all these models but none of them really work. We went into systematic trading and we figured out well, all of that modeling, yeah you believe in log normal of distribution of asset prices, good luck with that. There is something else going on.

We don’t believe in Santa Clause, we don’t believe in the efficient market hypothesis. So, why do we have all these people at the Fed, who, apparently as you say (if I understood you correctly), hugging their models and why is there not a greater openness of people inside those institutions to really look at the reality and the practicalities of life and say, “You know, those models, they really don’t work. They’re just models.”

Danielle

So, I’m going to tell you a story. Jim Bianco and I were up in Maine at an annual economics gathering put together by David Kotok. We spent an afternoon in a canoe fishing trying to figure out why Stanley Fischer, the godfather of central banking, would have come out of retirement in order to become Vice Chair, person number two, at the Federal Reserve.

Our conclusion was that (I had internal scuttlebutt at the time and it’s Chatham House Rules but now it’s in Fed Up, so who cares?), at the time there was concern that the board at the San Francisco Fed was a little worried about bringing Janet Yellen in, in front of Wells Fargo, because she knew so little about the financial system and she knew so little about banking.

So, at the end of three hours of fishing Jim and I concluded that it was the financial stability function that had brought Stanley Fischer out of retirement into the Fed so that he could shepherd (if you will) the global financial system because Janet Yellen wasn’t capable. Actually, I’m sorry, I’ve got my Fed chairs off, Ben Bernanke was not.

Anyway, long story short, Stanley Fischer’s first FOMC meeting, he stands up and he asks the room, “Why does the Fed use the PCE or the core PCE? Why do they use an inflation metric that does not apply on planet earth? Why don’t they use the CPI, the headline CPI? That’s what my inflation rate is. That’s what my children’s inflation rate is, why don’t we use the CPI?”

So, a very intrepid Fed staffer raised his hand in the back of the room and he said, “If we don’t use the PCE all of our models break.” At which point Jim Bullard raised his hand and said, “Let me understand, this is how we make monetary policy, crap in crap out?”

So, when I was at the Fed, in the heat of the crisis we started doing internal studies on why the core PCE had led the Fed astray; didn’t prepare them for the crisis. It was determined internally that they needed to come up with a new inflation metric so that they weren’t sideswiped again. After much soul searching, what they decided to do was nothing. They kept a broken metric that uses Medicare and Medicaid reimbursement rates to impute the most second largest input into inflation which is nothing. It’s not even in the same zip code as to what most Americans spend on healthcare.

They know and it’s an open secret that the way they measure housing and rental is also completely broken. Again, if they don’t have these models they’re not able to hide behind the 2% target. They would have had to normalize interest rates at a much faster pace and they know it. So, for them, it’s figuring out how to stay lower for longer after they blow up the financial system each time. The way that they were able to accomplish that, in the QE era, was by hiding behind the PCE.

Moritz

So, they’re hiding behind their models. They’re driving that broken car, essentially. That’s probably because they’re also independent and above everything that there are no external forces pushing them to change things.

Danielle

Well, they’re not independent anymore.

Moritz

Well, it’s changing, I guess.

Danielle

It’s not changed. The Treasury Department of the United States did a leveraged buyout of the Federal Reserve bank using N1 style accounting, setting up special purpose vehicles on its balance sheets so that the Federal Reserve could violate the 1913 Original Act. So, it’s done. Mnuchin gets a say in who gets the money. It’s post facto. Talk to Jim about it.

Rob

Is the Fed uniquely bad in terms of this kind of head in the sand believing in their own models? I have met quite a few central bankers and I think they do tend to become a bit institutionalized and stay in the same place (you’re obviously an honorable exception who has escaped) and get stuck in that group thinking that mindset. Are we being unfair on the Fed because this is just a problem with central bankers all over the world?

Danielle

I think that there are good people inside the Fed who do good work. One of them was my mentor, Harvey Rosenblum. He was, for 40 years, the director of research right under Richard Fisher. Towards the end of his career, he hired me. We had lunch as he was retiring and he said, “If there’s one regret that I have over my career it is not making the PhDs in the research staff do work that is applicable to making monetary policy.” They basically come into the Fed with their dissertation in hand and they spend the rest of their careers building up their pensions, redoing their dissertation and working in that body whether or not that body of work is applicable to monetary policy, and what the FOMC needs in order to operate is irrelevant.

That is why I have always advocated for getting rid of at least 50% of the PhDs at the Fed. If you’re God for one day, Danielle, where would you start? And I would blow up Minneapolis; blow up St. Louis; Blow up Kansas City; they’re irrelevant. They have nothing to do with the U.S. economy anymore. Janet Yellen clearly lost… And even her successor, with Wells Fargo blowing up and all the subprime mess, you need another district bank out on the West Coast and then get rid of half the PhDs.

Niels

What is also, to me, quite interesting is that central banks seem to have their different ways of measuring inflation anyways. The ECB doesn’t even include housing costs as far as I remember. So, it’s crazy, anyway, how this works.

Speaking about your side of the pond and our side of the pond, obviously, what we do know is that central banks are working very hard, they’re working overtime on their bond purchases and so on and so forth. At the moment, I guess, the word on the street is yield curve control. That’s clearly something that is either half started or is coming very soon. One of the things that actually surprised me a little bit is something I discovered recently.

We think about what could happen (and I’m sure we’ll get into this a little bit later when we talk more about inflation), what could actually happen for bond yields to suddenly start to go up? They have been going down for thirty-five years. What’s it going to take to change that? We think about, OK well, inflation might be the trick and so on and so forth.

In Europe, for example, as far as I know, less than 20% (it’s probably even lower now), less than 20% of the German government bonds are free-float. The rest is owned by the ECB. So, I know it’s different in the U.S. You still have a lot of publicly owned or privately owned (whatever you call it) bonds, but where is the pressure going to come from? We know it’s not going to come in Japan. They own their own stuff, like the ECB they have been doing this for a while.

So, it’s really only the U.S. that seems to, maybe, be facing the bond vigilantes (as I think Jim called them). When they start speaking with the same voice they could put pressure on the Fed. At the moment they’re not, but I was thinking about more global things. Government bonds are not something that a lot of people own anymore.

Danielle

Well so, in the hands of the public is about seventy some odd percent, I want to say.

Niels

In the U.S.

Danielle

In the U.S. More than a third of that, I think 36% (I calculated it recently) is held by foreigners, foreign ownership. So, we are decidedly beholding to the kindness of strangers, so to speak. Because we’re already running de facto Modern Monetary Theory, here in the United States, we’re giving people six hundred dollars more a week, Trump is worried that he’s going to lose the election so he’s going to come up with a stimulus package that is going to make Nancy Pelosi blush, but not call it that. He’ll call it austerity but it will be huge. But right now we’re already running, basically, socialism in the United States for all intents and purposes.

That is where you start to get into running up debts and deficits at such a fast pace while they’re saber-rattling, while we’re alienating the rest of our allies such that there is the risk (people don’t believe it could ever happen, but if you were to have foreign buyers step back from treasury auctions).

We’ve just seen the two largest months on record of declines in the ticks data in terms of foreigners selling their treasuries off. A lot of that had to do with the Fed was more than off-setting that, so it didn’t even cause a ripple in the bond market. You could have a situation where you go from presuming that the reserve currency status will always hold bond yields in place to flipping a switch, one day, and going to see bond rates spike overnight. Nobody believes it can happen. It’s the impossible.

I laugh because they even talk about yield curve control. What are they going to control, exactly? Things are on the ground. Are they going to say that the benchmark ten-year can’t go above 0.5? Maybe they can control that because they don’t have to worry about 1%; they don’t have to worry about a round figure.

Again, we are printing money and the reason that the debt ceiling was resolved as peacefully as it was, was not because Trump and Pelosi and Schumer all of a sudden were friendly with one another. That had nothing to do with it. It had to do with the very quiet writing into the language that there is no cap on debt spending (deficit spending) through June of 2021. So, whoever gets elected, basically, can spend whatever they want; put whatever they want into law. There’s absolutely no cap through a year from now. I think that that is something that foreign holders of our treasuries are aware of.

Rob

I was running a fixed income portfolio a few years ago and I remember everyone saying, “Well, there’s no way that U.S. ten-year rates can go below X where X was 3%, then it was 2.5%, then it was 2% now maybe it’s 50 basis points. You just have to look at Japan to know that they can always go lower. There is probably not much difference in a 50 basis point and a zero rate, to be honest. It’s not going to really make a lot of difference.

I guess the end game for this, naively, is inflation which would make this crisis pretty much unique in that, after 1929 there was massive deflation, I think there’s mild deflation after the mild recession, as you already talked about. In 2008 there was a fair bit of deflation, although quite short-lived because they did come in and rescue the economy.

So, is that how you see things playing out this time? How will that affect the U.S. dollar specifically versus other countries? If I just look at the fiscal response since the Corona Virus started, I think that, essentially, GDP, the U.S. is way up there compared to the EU, and Britain, I think, is lagging quite some way behind. I think our response is something like 4% or 5% of GDP and you guys are running at two or three times that. So, in a relative sense, what would this potentially do to currency valuations, as well?

Danielle

Well, answering that question requires coming up with an alternative to the dollar and I think that is where the world constantly gets tripped up. It’s that if there is no alternative to stocks, there’s still no alternative to the dollar. But there is something to be said for the Chinese and how they fit into this dynamic.

If we go from having a constant… Because we’ve been in a constant currency war. It’s been decades-long, this currency war going on in the background. That’s what QE is; that’s what blowing up these balance sheets effectively is, is trying to stay competitive on the global stage by devaluing your currency. The only way I can see that not working anymore is if China was to step back and not agree to go along with the growth in the U.S. debt deficit.

That’s when you start to talk about end games and debt jubilees, but these are real discussions that have to be had because if you ask most PhDs in economics, “What is going to happen in the event that there truly is an untenable level of debt worldwide?” The answer is always a debt jubilee. But a debt jubilee is… Jubilee is a very happy word, it denotes people agreeing to go this path in order to implicitly keep the dollar in its reserve currency position. If it comes down to that I can’t see that happening.

Moritz

Hmm, maybe that would be a really good answer, but going back one step, you’ve mentioned the 2% inflation target and you have been inside the Fed. I was always wondering, why is there a 2% inflation target? Wouldn’t a 0.0% inflation target be so much better?

Danielle

You’ve just quoted Alan Greenspan.

Moritz

So, who came up with that idea?

Danielle

You literally just quoted Alan Greenspan.

Moritz

Yes, I didn’t know that, but it seems to me like, why are we having this target which devalues our money over time? If you only do it for ten years and it compounds 2% in ten years, that’s already more than 20%. If you do it for twenty years, we’re probably getting close to 50% or something like that. So, twenty years is within all of our… That’s our lives, so, our models are saying that we’re going to be losing half the value, half the purchasing power over a twenty-year time span. I just found that ridiculous. So, who came up with that stuff and why is it not zero?

Danielle

So, it was the Ben and Janet show, internally. Alan Greenspan was adamantly opposed to it. It’s in an FOMC transcript and he has said the absolute best inflation target, whether it’s from the perspective of a household or a business, is zero and it should always be zero.

Janet Yellen and Ben Bernanke were fighting, and fighting, and fighting for this two percent target for years but it wasn’t until Alan Greenspan left the Fed that they were able to actually implement it. If you recall, at the same time (along the lines of making really stupid decisions), they implemented an employment rate target as well which they kept moving down, and down, and down, and down because it was also completely senseless.

Sadly though, it has now been adopted by global banks around the world. They have all got their targets. Again, these targets are nothing more than an excuse to hide behind printing money. To me, at least they are very administrative. They have a utilitarian role that they play within central banks in a world of growing balance sheets. If you had as a zero percent inflation target you would have to turn off the printing press.

Rob

I’ll just interject with a quick correction of facts. I believe that we have inflation sovereignty in the U.K. for about ten years before the U.S., but that’s beside the point.

Danielle

But in the United State it was definitely a huge subject of debate.

Rob

Definitely.

Danielle

That’s when I was inside the Fed. It was a hot, hot, hot subject. Again, until Greenspan left it was a nonstarter.

Rob

Sorry, Moritz or Niels, back to you guys.

Niels

No, that’s fine, that’s fine. Just maybe shifting gears a little bit but still staying on the same topic about how does all of this come about at some point. We talk about different cycles. I don’t know whether you subscribe to Ray Dalio’s big long-term debt cycles, etc., etc. Another cycle that is of interest and is something that the three of us have talked about on the podcast, recently, is demographics and more specifically the Fourth Turning.

Generational cycles from the book written thirty years ago where they foresaw that around 2005, OK, it became 2008, the Fourth Turning kind of started. We will probably have it with us for the next ten years or so. We can certainly see a lot of the similarities from previous times.

But, the point is, all these Fourth Turnings end up in either hot war or revolution or something along those lines. There is certainly a lot of geopolitical stuff going on right now that could ignite (let’s put it that way), this time around. Even in the U.S., I guess you’re close to it, you could certainly say that there is not just civil unrest, there is uncivil unrest going on. Does this end like all the other Fourth Turnings do you think?

Danielle

I think that what is most hopeful for Americans in the middle, right now, is that there is more clarity than we had going into 2008. There is a better appreciation for the role that the Federal Reserve plays.

I think that if there is any time in U.S. history that there is going to be a revolution, I think it’s going to be now. And I don’t say revolution, guns in the street (God forbid), but I’m talking about a large enough percentage of the population who feels that on November 3rd they have no choice that they can make. So, they are completely unrepresented.

I don’t speak as a radical. I’m not speaking out of turn. My opinion is widely shared right now. There are several movements that are coming from very rational, calm, successful people (I’m not talking about the private equity billionaires, they’re special – let’s put it this way, non of them go to Davos).

There is a movement about (in the United States) for there to be a pathway forward that does not involve the way government is run today. I think that it is grounded in the fact that decimating the middle class for decades has now left such a disproportionate amount of people in the lowest income brackets as well as this gigantic sector of America that wants Modern Monetary Theory; that wants to get paid to not work; that advocates for Socialism even though they can’t define it.

If you go around the far left and the far right I think that you’re gaining critical mass in the United States that could be sufficient to bring about true change in Washington D.C. That is the first time that that can be said in my mother’s life who is in her seventies and lived through the Civil Rights Movement. She’s telling me that she has never seen anything like this and that she’s hopeful at the same time. Again, on Election Day, millions, upon millions, upon millions, upon millions of Americans will go to the polls with no choice to make.

Niels

It’s quite interesting. So, I’m Danish by background but I live in Switzerland and I have been living here for a long time. As you know, we vote on everything. That’s Direct Democracy. Actually, in Switzerland, there has been a vote, and I can’t remember if was just a few of the cantons, but within the last three or four years, I would say that we had a vote on universal basic income. So, some cantons wanted to have this, I think it was like two and half thousand francs a month. It was voted down but it is so unique to see how this political system works compared to others.

Of course, I share your view and hope that this will end peacefully, although history tells us differently. On the other hand, as far as I remember from the Fourth Turning analysis, this is the period where a third party may rise and come. Was Trump not that third party, so to speak? He came from the outside and got adopted by the right.

Danielle

No, no, when you have elections of people who, when somebody gets elected because somebody is voting against somebody that’s not a revolution. That’s just a backlash. Right now you have three Republican political action committees in the United States that are raising money to elect Biden. That’s also not a revolution it’s just a backlash. It’s just a vote for change or making sure that person doesn’t get elected. That still leaves most of the conservative-leaning, raised Republican, GOP, fiscally conservative, doesn’t believe in all these… It still leaves a whole bunch of people with no voice if Biden comes into office and immediately imposes universal basic income.

Niels

And, of course, he could spend for the first year or so.

Danielle

June 2021, unfettered.

Niels

Interesting.

Rob

Yeah, I think, unfortunately, the experience of direct democracy, especially today with spending money in places like California, is not great. Obviously, they ended up with their hands tied behind their backs in terms of what they could do with the budget and the sort of built-in deficit effectively from that. Anyway, maybe the Danes are just more sensible than the rest of us.

Niels

No, it’s the Swiss. It is the Swiss that has Direct Democracy.

Danielle

But Finland already went through the experiment. They passed it and it failed. The people on universal basic income, there was a small subsector that was happier, but the employment rate didn’t do anything. So, it was just kind of dead in the water. We’ve got real-life experience with this.

Rob

Yeah, Direct Democracy didn’t work too well with Brexit in the U.K. but that is definitely another discussion. So, just running back slightly from the politics, I did say earlier that I liked your mention of inequality and the Fed’s policy is perpetuating inequality. So, I guess we’ve kind of… QE has increased asset prices, which is great if you are in assets. That’s been really pretty poor for inequality. The changes in the U.S. taxation system, under Trump, I think most people would agree have been pretty regressive. I think you, actually yourself, have written about the fact that Covid has been really bad for inequality as an event.

So, I think there are various axes we can look at this from. We can, obviously, look at race which is very topical at the moment, obviously. We can look at gender; women’s incomes have generally been hurt more by this crisis. We can go back to demographics as well; it’s the baby boomers. They have got the assets and maybe more of them are working in safer jobs and they weren’t the first in line to be fired which the younger generation is possibly worse.

So, it does feel like all of these kinds of axes of inequality are all happening at the same time. You can be pessimistic, like Niels, and say there is going to be a war or you can be optimistic and hope that there is going to be change. I don’t know. What are your thoughts? If you don’t think what the Fed is doing right now is great for inequality, and I don’t think it is, you think that basic income is a non-starter, so, what are we left with?

Danielle

Well, we’re left with change. We’re truly left with…

Rob

Change to what? Change to what, though?

Danielle

Let me put it this way, there used to be lines of demarcation. The Republicans in the United States used to be the party of business and they were the ones who were always on the side of capitalism, you think of Reagan. That changed a few generations ago with Clinton who, people forget, Bill Clinton did the most cutting welfare reform in the history of the United States as a Democratic President.

When the Democrats moved over to the side of commerce it ended up being the Democrats and the Federal Reserve and the Republicans all working in favor of commerce. You’ll note that Wall Street gave more money to the Democratic Party in recent elections than it has to the Republican Party because it knows that the Democratic Party is in its pocket. What that means, and the reason that this has widened the inequality gap, as much as it has, is because of the traditional voice of those in need, the traditional voice of the up-and-comers, of small businesses in America.

We used to have 50% of jobs in America that were at small businesses. That has come down to 47% pre-Covid. I would argue that that is going to be cut in half again – a massive tragedy for (what you think of as being) the American Dream and innovation because nobody has been there for the small business.

If you look at the Fed’s facilities, they have barely been used, barely, barely, barely – the swap lines. As far as the facilities that they have created they have barely been taken out. Illinois has got 1.2 billion of debt out to the Fed’s municipal program because it was going to melt off the planet because its pension is so bad and its politicians are so corrupt.

Nobody has been there for the little guy for generations – since Bill Clinton was in office. That is what has really made the inequality divide that much worse and then you put Fed policy on top of it. That’s why I say it’s a third party to speak for the people who the Democratic Party used to speak for and to speak for the middle class that used to be represented by the Republican Party.

I mean revolution is… I can’t see myself taking up a gun. So, I hope it doesn’t come down to that, but whatever it takes to get representation for the taxation is what is going to be required. I think that there is enough of a movement.

We are tired of seeing children left behind in the public school system and paying these huge taxes. If we don’t educate our youth there is never going to be a way out, a way out of this vicious cycle of poverty and indebtedness in America. That is a drag on the overall economy that makes us that much less competitive with China.

Moritz

So, all of us being traders, at least I am particularly interested in what your outlook for markets are, going forward. We may start with things such as gold. Everybody seems to have an opinion of gold. Most of the opinions that I hear are bullish gold. I’m not sure if you agree. What about bonds, equities, other things, credit, bitcoin? What do you think? How would you position yourself?

Danielle

Well, I can tell you how I am positioned rather than telling you how I would be.

Moritz

That’s even better.

Danielle

We invest in start-up companies; direct seed money; large, huge positions. Just talking about my household, large position in gold; large position in a volatility fund; and municipal bonds and that’s it, soup to nuts.

Rob

That sounds like a classic kind of “Talebian” sort of Bar Bell portfolio, doesn’t it? I assume that volatility fund is long volatility?

Danielle

Yes, it is.

Rob

Yeah, its tail protection.

Danielle

But he plays… Is Artemis Capital, Christopher Cole, one of my… He’s shout-out brilliant if you have never interviewed him, you need to set aside two hours.

Niels

He’s been on the podcast a couple of times, yeah, we like Chris, yeah.

Danielle

Yes, Chris is extremely frustrated because, from the perspective of a trader, right now, you’re fighting the Fed (and you’re never supposed to fight the Fed) and you’re fighting a socialist in the White House. So, you know the stimulus that is coming is going to be enormous and that’s why we don’t have rising automobile delinquencies; that’s why ABS investors have been covered; that’s why we haven’t seen car repossessions; that’s why we haven’t seen rental evictions. We haven’t seen mortgage defaults. We haven’t seen foreclosures. We haven’t seen any of the things that you would normally see with unemployment at, what did I say, 18.6% in America. Yet, we don’t have any of these things because of the stimulus measures. Too, credit cycles are not playing out except for companies that are defaulting. I think there were three companies that have defaulted in the last twenty-four hours.

Niels

One of your Real Vision friends, another one I guess, Raoul Pal, he talks about these three phases that he sees. I can’t remember the wording for it, but it’s like the unravel which we have kind of been in; and then you have the hope phase where we hope it goes back to normal; and then comes the insolvency phase. Do you subscribe to that vision, that that is where we are heading, that at some point soon (as you say) you can’t print jobs, you can’t print cash flow? Is the inevitable that we’re just going to see a massive wave of insolvency hitting both the U.S. and Europe for that matter?

Danielle

We do have insolvencies with companies of fifty million or more in debt at the highest levels since 2009, currently. So, I don’t think that the insolvency is theoretical; I think it’s practical, it’s happening. If I sleep for eight hours I am going to wake up and some company is going to be on the wires on Bloomberg as having filed chapter 11.

Niels

Yeah, I wanted to ask… And I know that every time you ask these questions you maybe get labeled as a conspiracy theorist or whatever it’s called, but I still want to ask you, because you’re closer to these things.

You mentioned Covid 19. We all know about it. I know you mentioned a couple of months ago on another interview on the ValueTainment you mentioned this interesting timing of when China inserted an opt-out clause in the trade deal, and when they announced the first case of Covid and all of these things. I just want to, more broadly speaking, ask is Covid a real pandemic, or is there more to it?

We hear so much about Bill Gates’ role, his connections to WHO, to Dr. Fauci, to all of these things. When you read the Fourth Turning, by the way, one of the eight scenarios that they list (and this was written thirty years ago) one of the eight scenarios that they list as how this could happen is the CDC coming out and announcing a pandemic and asking people to socially distance themselves and all of those things. It’s a little bit scary to read something that is so close to what we have now. Do you subscribe to any of this or is it just random?

Danielle

So, one of my fixed income subscribers, one of my institutional subscribers reached out to me randomly, in early December, and said, “Danielle, I want to talk to you about Covid.” And I said, “OK. What does Covid have to do with fixed income investing?” It was a woman, she said, “Actually, I’m a twenty-year veteran epidemiologist.” I said, “Oh, well.” And I picked up the phone and called and two hours later I got off the phone with her.

Having somebody explain that something has CoronaVirus attributes and HIV attributes and tell you (and she’s not a conspiracy theorist, she’s just an epidemiologist by training) and says that this is not something that occurs in nature is very unsettling. We have seen, in different demographics, in younger people, how it plays out in the body and starts to attack the organs the way that HIV does. So, it’s not a pure CoronaVirus in the way that it manifests physiologically. That’s undeniable. It’s documented.

It is bothersome to me because Scientists can’t figure it out. It was bothersome to me that Carrie Lam came out, when there was the first CoronaVirus case in Hong Kong, and told the people of Hong Kong to not wear masks. They did, they had a grassroots campaign, they came together. They’re pretty good at grassroots campaigns at this point. They came together and they all wore masks and they have not paid the price with human lives. Our government came out, initially, and said, “Don’t wear masks.” Now masks have been weaponized and politicized.

Where I am, in Texas, I’m a prisoner in my own home. I can’t go out because there are so many Trump supporters, where I live, who feel like, even if they want to put a mask on, if they do put a mask on they’re saying to the public that they don’t support their leader anymore. So, they don’t.

So, it’s just insane that this thing has been politicized, in my view, and the fact that (forget the Chinese knowing about it) the first case in Wuhan was November 17th that we know of. Taiwan canceled major games in Wuhan in early December. So, it was off the mainland by then. Of course, the trade deal wasn’t signed until January 15th. President Trump had internal briefings in early January before he signed the trade deal.

So, the trade deal was signed with full knowledge of both parties with the unintended circumstances out-clause with the CoronaVirus known on both sides. It was just a pure political ploy because both sides knew that they could get out of it. But, beyond that, the whole mask issue, and hearing people of power say, “Don’t wear masks.” To me, especially now that people feel like they’re being hurt by it, it’s extremely politically disruptive. It is making Covid, in the United States, a much more political and deeply economic event than it is going to be in other countries.

If you look at Germany and its reopening and you look at Germany’s curve, it goes up very high and it comes down very low and now, if you look at open table reservations in Munich and Berlin they’re ticking up slowly as opposed to what has happened in States that reopened prematurely, in the United States, because they were doing it for political reasons, to stand behind the President and now we have seen the reservations in Atlanta Georgia and Dallas Texas, they went straight up as the economy re-opened and they have come crashing straight back down as the economy has re-closed.

This will have severe circumstances, again, for small business owners in these areas who were affected but not backstopped by any decent legislation. The people who are backstopped are the people who make nothing and who get money and who are making more money, right now, to stay on the sidelines and not work and the people who have investments. The people in between, again, are absolutely not represented, whether you’re talking about fiscal stimulus measures, the Federal Reserve policy, there is nobody there for them.

Rob

I have a bit of a word association. Whenever Niels mentions conspiracy theories I immediately think about cryptocurrency because most of the people who follow me on Twitter (and they’re into bitcoin also), for some reason (I don’t know why) they’re also quite keen on conspiracy theories.

So, let’s talk about cryptocurrency because some of our other guests have said that the way out of this potential massive inflation of fiat currency will be some kind of central bank-issued digital currency. It would seem remissive not to ask someone who is so well connected within the central bank world, like yourself, to ask you, firstly, what do you personally think about that; and secondly, given any discussions that you have had with people who are still insiders, how likely and realistic is that?

Danielle

Well, when you write a book that’s subtitle is Why the Federal Reserve is Bad for America, you don’t have many discussions with people on the inside after that, just FYI. It was already a point of discussion years ago and it was much more of a national security discussion inside of the Fed. The first three countries to adopt cryptocurrency were Venezuela, China, and Russia.

The Bank of England immediately took up the discussion and I think that there is a presumption, within the Federal Reserve, that at some point we will have Fed coin. It’s an inevitability. It’s also a technological inevitability. Covid has put that into high gear as well – turbocharged the need for as little tactile transacting as possible between humans.

So, I think that it’s not necessarily economical the way that it is mined, so to speak. I’m not a bitcoin expert, and never tried to be, and they’re all over my Twitter feed whether I want them to be or not. But I do think that it is inevitable.

I don’t like the aspect of it. J. Powell is adamantly opposed to Fed coin. The part that’s unsettling, and the reason that China, Venezuela, and Russia were the pioneers, if you will, is because they want to use it as a means to monitor the citizenry. That’s bothersome to me. That’s about as anti-American as you get, but so is a lot of stuff in the country right now.

Rob

Is there also a degree of the Chinese, for example, wanting to develop this currency to kind of break the deadlock that the U.S. dollar has on global trade, allowing the U.S. to sort of fund itself?

Danielle

I think that that’s the same discussion that you would have whether you’re talking about the physical Yuan or a Chinese cryptocurrency. You still have to trust the other side of the party. I still think that there is very little in the way of trust in the idea of it being a store of value putting confidence in the Chinese given everything.

Moritz

It would be an opportunity for another nation to come up with whatever their Fed coin is going to be if they make it real hard fat coin, not a weak fat coin where the algorithm allows for inflation. Of course, I know this is what everybody wants, where they still have the control and they can do whatever they want with that thing. But if they did a bitcoin type of style where there is a cap on the amount of coins that can ever be issued – something like that, that could be competition to the U.S. dollar. If somebody went shopping with that saying, “Here’s the thing, we’re not going to be inflating that away. How about we trade in that one.”

Danielle

Right, that’s the marriage of gold and crypto, what you’re describing.

Moritz

Yes.

Danielle

You’re describing the perfect, modern, disciplined form of currency. That’s utopia.

Moritz

Well, I’m not sure it is because if you do it with crypto, you have bitcoin maybe energy-intensive to mine and all of that, and maybe that’s getting more efficient, but at least you don’t have to dig it out of a hole. You don’t have to mine it, use lots of energy in order to extract it and all of that type of stuff. Then you store it. It’s much more efficient in that regard.

Danielle

It’s modern.

Moritz

Yeah, exactly, so, you could come up with that and say, “You know what? There is a limit to that. This is in the algorithm. There is a limit. There is going to be that many Fed coins but no more. Let’s deal with it.”

Danielle

Well look, if we manage another four years of alienating all of our allies then that could very possibly happen.

Moritz

Yeah, I think so.

Niels

The other thing, I guess, is that with the policies that we’ve seen in the last ten years with interest rates, certainly in Europe for a while now being at zero or below, it’s killing the banking system anyways. It will end up that we all become clients of the central bank because there will be no real banking system underneath it.

Danielle

That’s exactly right and the one thing that I will give J. Powell credit for is holding the line on negative interest rates. It’s clear from listening to everybody on the committee and every district president that there is unity and a cohesive solid front against negative interest rates. You don’t have to be a rocket scientist. You don’t, you just need to look at the Euro stocks index, look at what has happened to Japanese banks and say, “Oh, wait, sorry, that failed,” and walk away.

Niels

And I get that, but if you look at some of these short-term interest rate futures they are flirting with one hundred; they’re flirting with negative rates and we know how markets sometimes force the hand of the central bank at the end. Personally, I think we could end up with a surprise appearance of inflation, so, that might save them. Failing that, it could be tough for them to hold onto that stance.

Danielle

If the confidence in the Fed put was to degrade then that would be problematic – if we were to have everything step back again. You may recall that during the heat after the onset of the crisis there were times, in Asian trading, that you could not transact in the long bond. Treasuries dried up in the middle of the night, mysteriously. We saw that this is the world’s risk-free asset and you couldn’t trade them in Asia. It was bizarre. It was terrible. It freaked out J. Powell, with good reason.

Niels

Yeah, you kind of touched upon this, also, with the Powell Pivot in 2018.

My last question, just generally speaking, would be is there an Achilles heel somewhere in all of this system? It’s so interconnected; it’s so integrated; they’re all trying to manage things. Maybe, OK, maybe the pressure valve will be the currencies and that’s where we’re going to see the volatility after a quiet period for a few years, who knows. But they’re trying to manage equities; they’re trying to manage fixed income; in doing so they rely on certain things. We have clearing systems, margin, whatever, is there some kind of an Achilles heel that could break this party?

Danielle

I don’t know where systemic risk is. I truly don’t. I would say that the leverage loan market, the private debt market, the junk hiding inside of investment-grade, if you add it all up you get to something that is much bigger than what subprime was, at the time. It’s definitely global in that you’ve got Japanese banks with high concentrations of this garbage on their balance sheet and it doesn’t trade. None of them have covenants either, so, when something occurs with one of these pieces of paper such a gap opens up. It’s like this big vacuum sound and you’re like, “Bonk,” it went from 90 to 20 cents on the dollar.

Again, the private debt market is seven hundred and fifty, seven hundred and sixty billion dollars outstanding. We knew that, coming into this, small/medium enterprises had more debt on hand than large companies, which is saying something. So, I do think that the hidden leverage in non-financial debt in the United States is very problematic.

When you look at the corporate debt market and you say that that’s 48% of GDP, but then you look at non-financial debt which is almost upwards of 16.5 trillion or so, that’s 75% of GDP. So, there is 25% of GDP that’s fairly invisible to the public investor and it is scattered throughout the economy. Some of it has been securitized, some of it is not.

My point is, we don’t know what it’s going to do or how it’s going to behave in a world where all of these debt instruments were created because you couldn’t get yield from anything. So, investment bankers did what they do, they got very creative over the last five years especially (with a lot of the real estate deals as well).

Nobody is even paying attention to FRED right now. We’re seeing multi-family delinquencies go up. That should, theoretically, be impossible, demographically speaking, in the United States. However, you’re seeing de-urbanization in the United States which implies that the 82% of apartments in America, that were constructed over the past decade for luxury, are not going to be occupied. It’s attached to office real estate.

The valuation of these are through the roof, and, again, they have also been securitized. So, that would be my only guess is that it’s the debt that you don’t readily see that you wouldn’t pick up, whereas you would say, “There’s a CUSIP for that.” It’s that, that kind of worries me because I don’t know what it is. I just know it’s really big, 25% of GDP.

Niels

Yeah, there are many other topics that we didn’t even get started on but we do want to respect your time, Danielle. So, thank you ever so much for spending some of your afternoon with us. We really do appreciate it as I’m sure all our listeners do. By the way, make sure that you follow and subscribe to Danielle’s work on Twitter and Quill Intelligence, of course. As you can tell from today’s conversations you’re missing out if you don’t.

From Rob, Moritz, and me thanks so much for listening and we look forward to being back with you as we continue our Global Macro Miniseries. In the meantime be well.

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