Jim Bianco – Global Macro Series - 21st August 2020

Jim

There’s one group larger than the Fed and that is what Ed Yardeni coined forty years ago – The Bond Market Vigilantes. The collective wisdom of the bond market is larger than the Fed.

The problem is that the bond market, right now, is not of a collective wisdom. It is not of one thought. There are people there all over the place in the bond market. Some are bullish, bearish, up, down, left, right, forward, backward.

But if you get inflation and then everybody is of the perception that inflation is here eroding the value of fixed-income investments, then they become of one mind and that one mind is to sell. Interest rates go up and then, at that point, the Fed can’t stop interest rates from going up until the market demands that they just stop with the profligate policies.

Niels

For me, the best part of my podcasting 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 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 to make us better-informed investors and we want to share those conversations with you.

Our Guest today is a true master when it comes to providing objective, data-driven research with a unique perspective. So, I’m convinced you will enjoy our conversation with Jim Bianco of Bianco Research.

Jim, 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 a 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 for this future.

So, we’re super excited to dive into many different topics in the next hour or so, not least because you are one of the most prolific researchers that I have come across. What I love about your work is that you are very generous when it comes to sharing it on Twitter and other platforms. So, welcome and let me just kick it off with a kind of 30,000-foot question, if you don’t mind. We’ve had a number of guests on this series and I ask all of them where they think we are in a global macro picture.

To me, at least, it feels like it’s kind of a blend of things we’ve experienced before. There are a lot of analogies back to 1929, the 1930s. There are people talking about the Japanese Bubble in the late ‘80s; of course, we refer back to the Tech Bubble; the Great Financial Crisis, then, on top of all of this we have this global pandemic that has come into our world which makes it a pretty unique time to be alive and to be an investor. So, let me just kick it off, Jim, and get your big picture right now.

Jim

Yeah, thanks for having me. I have to start with that this is unlike anything that we have seen before. First of all, you’re right; we’ve got a global pandemic going on. This is not the first time in history we have ever had a pandemic. Interestingly, this one came at the height of a very long expansion and at all-time highs in financial markets. Most of the other ones, whether it be 2009 with SARS, 1968, the Hong Kong Flu ’57, or 1918, just to name off a few, usually don’t come near all-time highs. It’s more a coincidence than anything else.

On top of that, what we did this time that’s unique to all the other ones is that we effectively did a global economic shutdown. That’s never been done before. No one really knows what that means and we’re still all trying to feel around in the dark as to what its implications are.

So yeah, we use a lot of analogies that it’s like the ‘30s here, and it’s like 2008 here, it’s like 1918 here, but we’re all just guessing because there is no road map for something like this that we’re looking at right now.

Niels

Yeah, absolutely. I’m going to just stick with you for a little while and ask a couple of bigger questions and then Rob and Moritz will join in. I did notice that you have a webcast out recently, maybe even this week, where you talk about a few big topics which I think we’ll spend a little bit of time on today, without a doubt.

We’ll talk about rates and where we are on that. Obviously, we’ve seen a massive change in retail investor behavior, and then, of course, the world is trying to manage reopening the economies. You mentioned about the shutdown which is definitely unique, and now we have this equally unique situation of how do we restart this thing?

So, let’s just jump in, maybe, at the first point and that’s interest rates; and also I think some investors will sit back and look at what has happened in the equity markets in the last few months where we had, certainly, quite a lot of volatility. I think the first time ever we had a yearly outside reversal where we hit both new highs and new lows compared to last year. Yet, in the last couple of months, interest rates have not moved dramatically. So, tell us a little bit more about what you’re seeing in that space.

Jim

Interest rates have probably been, in my mind, the more interesting of the cases because what is happening there is a question about whether or not there is still a market signal left in interest rates. That’s because of the heavy involvement by, let’s say, the price-insensitive buyer of the Federal Reserve. They, literally, create the money that they’re using to purchase securities. So, I’m of the opinion that they have greatly reduced the signal there.

Not only is the Federal Reserve buying bonds, but let’s be more specific, they’re buying mortgage bonds, they’re buying Treasury bonds, they’re buying corporate bonds including junk bonds (anything that has been downgraded since March 22nd otherwise known as a fallen angel), they’re buying ETFs, they’re also looking at buying loans (whether or not they’re Main Street loans or paycheck protection plan loans), and they’re also looking into the possibility of buying municipal bonds as well too. They’re doing it in an aggressive way; in a way that we haven’t seen them do it before.

So, it begs the question that the reason that we have markets and the reason we have people like me that look at markets is we try to look at the signals that markets are telling us to give us an idea of where the economy is going to go. I don’t think I can trust any of the signals in the bond market, right now, with this big of a buyer. That’s why I have always marveled at people that will go into great detail about, “Well, the yield curve was here and it went there and now it’s going over here.” I don’t know if it tells us anything as long as they’re not freely traded markets.

Within that, taking a step back, what has also happened, if you look at the investor flows, is that since March, investors have been bailing out of the bond market in a big way. They were selling corporate; they were selling Treasuries; they were moving themselves into money market funds. Foreign central banks even sold over one hundred and fifty billion dollars worth of Treasuries as well, too.

At the same time that they were doing that, the Federal Reserve stepped in and was, at one point, buying over one hundred billion dollars a day of bonds. Now, they’re down to about five to eight billion dollars a day, today, currently. But it looks like what they’ve been effectively doing is the words you hear all the time, “yield curve control.” All that means is price-fixing; that they’ve been trying to fix the price of interest rates.

I think that we’ve already had it and that’s why the bond market has exhibited very little volatility and its yields have not moved much. That’s why, like I said, if that’s indeed the case, you have effective yield curve control from the Fed, and they have been off-setting whatever selling that the private sector did and then backed off when the private sector stopped selling. I don’t know if you’ve got any signals out of the bond market at all.

So, it’s going to be very tough to use it as some kind of a mechanism to tell us how the economy is going, what the state of inflation is, and everything else. So, it’s an unusual period because we have not seen anything like this. About the closest example that we have, in modern times, might be Japan and the same thing applies there too. This signaling that you’re getting out of the JGB market about the state of inflation and the economy in the Japanese market is very loose if nonexistent. Whatever JGB is doing doesn’t tell you a whole lot about what is going on with the Japanese economy.

Niels

That’s interesting in that you talk about signaling from the yield curve, because as part of our global macro series we’ve had Cam Harvey on who is obviously the inventor of the yield curve indicator, so, of course, he believes that, at least back in June last year, there was a signal and he called it, I think it’s eight for eight now in terms of signaling a recession. Do you put any weight, or have you, historically, put weight on his way of looking at the yield curve to predict recessions?

Jim

Yes, I know Cam, and I think his work has been truly fantastic and I was with him, last year, exactly saying that, that the inverted yield curve was a signal that interest rates were too high. That, to me, is what an inverted yield curve means, if you want to put it simply it’s when long-term rates are lower than short-term rates. They’re just saying that short-term rates are too high and it’s restrictive, and it can produce a recession. I was there with him on that.

We did get a recession but, “Oh, it was a pandemic.” The yield curve couldn’t have predicted the pandemic, true, but we will never know what would have happened without it. Maybe we would have had a recession anyway without it. I tend to think that way as well.

But, since March (I’m talking about since March not forever), when the Federal Reserve stepped in, in a major way like we’ve never seen before, I think that I’m starting to question signals that I’m getting. Again, it’s not a freely traded market. It is not the intersection of buyers and sellers making conscious decisions on what they want to do. There is a big player in there that is inventing money out of thin air and is using that to manipulate markets to a particular end. So, that’s why I have been very suspect, since March, about what is going on in the economy as I measure the interest rate market.

Niels

Sure, Rob, what’s on your mind?

Rob

Let’s just do a little bit more of this looking back and comparing where we are now versus what might have happened before. I guess, the commonality between this crisis and the last one, in the post-2009, is the fact of this massive intervention by central banks. How would you compare the kind of quantity of that intervention then versus now?

In other words, the last time there were concerns that the intervention, basically, ended up pushing up the price of bonds, which is obviously what we wanted, but that then did not lead to banks lending more money, the price of credit coming down and an increase in consumption on the other end. That didn’t really seem to have much of an effect on the real economy. Is there more likely to be a better outcome now, do you think? Have we learned our lessons, or is it time for another approach? Or is it a question of that they’re just not doing enough?

Jim

You know, that’s a good question and I’ll answer the question this way. Remember that in 2008 and ’09, when they did their extraordinary interventions, it did produce a recovery… A recovery came in the wake of those interventions (say it that way). That recovery lasted for eleven years and that was, at least, in the U.S., the longest expansion in history.

What is not often talked about, what that expansion is, if you look at the total gain of GDP over those eleven years, it was something like 35%. It moved up, in aggregate, 35% higher than it was in 2009. That actually ranks as below average. So, you had a very long recovery, but in total it was a very below average recovery. I have attributed that to that intervention removes or dampens the animal spirit, dampens the creative destruction (whichever metaphor you want to use) for capitalism. While they are able to suppress the cycle so that it lasts longer, the consequence of that is a cycle that is a lot shallower.

So, that’s why I think we saw the political polarization and we saw a lot of the angst like the Tea Party movements and everything else about the state of the economy. So much so that we had a bit of a rebellion; not only a rebellion in the United States, but around the world with Brexit and with Trump – that they were a bit of a rebellion against the status quo, not because people were unhappy (at that time we were entering the seventh year of an expansion), but that it was a very poor expansion.

So, now we seem to have taken the wrong lesson, from 2008 and ’09, and we’re going a lot harder about trying to use a lot of intervention to fix the economy. I’ll cut it down for you really quickly. It comes down to one simple fact: who measures what.

Now you guys and me, we might all think, correctly, that the idea of financial markets is that they’re supposed to reflect the real economy. So, whatever the real economy is doing, it gets reflected in the markets (the level of the stock market, the level of interest rates) not precisely every moment (they can diverge a little bit), but over time they come back and forth to each other.

That certainly is what Warren Buffet has been arguing and what a lot of high profile hedge fund managers, whether it’s a David Tepper or Bill Ackman or Stan Druckenmiller when they have expressed cautiousness in the economy. That’s part of this disconnect argument you hear that the financial markets have disconnected from the real economy; that they have run way ahead of the economy.

But, I think at the Federal Reserve and at a lot of other places, and certainly the Twitter feed of the President of the United States, they believe it’s the other way around. They believe that the economy reflects the stock market.

So, when Trump keeps chortling, “Oh, new high in the stock market, jobs, jobs, jobs.” He thinks that if you ram the stock market higher (just randomly ram it higher) it will create confidence, it will create jobs, it will create GDP. The economy will then reflect the stock market. I think the Federal Reserve thinks that. I think that the Treasury Secretary thinks that, and I think there are a number of other people that think that as well too.

That used to go by the old name called “The Wealth Affect”. So, I think that’s going to really be the question of the day: which reflects what? Right now I think the driving part of the policy is if we boost markets and if J. Powell comes out in his press conference and says, “Well, the markets were illiquid and companies were going to go out of business, but then we stepped in and we saved them and they got financing.” Then they think that they’ve done a good job because they think that they have then increased the ability…

J. Powell says this, “The free market was going to let these companies go out of business but we prevented it and we saved those jobs.” Maybe the free market had a good reason to send those companies out of business. We’ll never know because you stepped in and you circumvented the effect. Really, which measures what?

We all may think that here’s the economy and that’s why we employ economists to tell me what the economy is doing and then I’ll back into what the financial market should be. But in 2020 it’s more like, “Put the financial markets at some arbitrary level and then watch the economy adjust to that level.” That was certainly the case in March. They were afraid of… When all the financial markets arbitrarily took out 35% of their value, went down, the fear was that the economy was going to adjust to that. So, then we forced it back up so that the economy could adjust back higher. That’s the precipice of the argument: which drives what? This is really how we have to think about it.

Moritz

I think what we also see is that people start to realize more and more that what you describe as The Wealth Effect tends to work better for those people that have assets, which are long stocks because they can immediately enjoy it. Those people who don’t have assets, so not as many assets, and aren’t long stocks, they’re kind of left on the sidelines. It leads to more central bank intervention extraordinaire. We’ve had quite a few.

It’s not just that we’ve had the Global Financial Crisis 2008, 2009, and a couple of interventions there, and now we have a couple of interventions right now. We’ve had quite a few in-between, which, I’m not sure if people want to forget about them, but there’s been Operation Twist Quantitative Easing One and Quantitative Easing Two… And it’s kind of that like every year, every second year, there has been something going on.

It seems to me that maybe the markets are like a drug addict where as soon as there are withdrawal symptoms, the Fed has to do something new – pull a new trick out of the hat. So, what do you think, Jim, are we getting to a point where maybe the Fed and other central banks have done enough or is this just that we’re pausing a little bit, but rest assured, the next central bank intervention, the next trick, whatever the case may be, explicit yield curve control, you name it (there are many options available), the next trick is probably a couple of months away.

Jim

Oh, I agree that the next trick is just a couple of months away; that they’re not going to stop doing this. I don’t think that they will ever really want to stop doing this as well too. To the first part of your question about inequality (which is what you were asking about), yes, this does create a big inequality.

Forty, forty-five percent of the American public owns equities. They are benefiting from the Fed using financial markets as a monetary policy tool. We’re going to push up financial markets and we are then going to, hopefully, create the confidence in jobs that I talked about.

The other forty, forty-five percent of the public that owns no stocks doesn’t benefit from that. But they’ve been satisfied because they’re getting an extra six hundred dollars a week in unemployment; there have been stimulus checks that have been mailed out as well too.

The problem that I see with this is you are fostering that inequality and it shows up in the most obvious ways. In the U.S. right now we are talking a lot about whether or not there is a retail mania going on in the stock market. I believe that there (hands down) is. I happen to think it’s larger than the 2000 retail, or 1999 retail stock market mania, although, admittedly, it’s how to measure it. So, there’s a little bit of guesswork in there. But, never the less, it is very large.

What’s driving that? Stocks always go up. The Federal Reserve has been buying stocks. The President of the United States Tweets out, “We can’t let the airlines fail. We can’t let the energy companies fail.” The public (especially small retail), that doesn’t own stocks, “Oh, I get it. I get it. This is a risk-free investment. That they’ve got an unlimited printing press and the President is telling you, none of these companies will fail.”

I don’t know what Warren Buffet was thinking when he sold all his airlines in the middle of May, but the government told you they won’t let them fail, so get in and get in in a big way. That’s why you have had this rush of retail and all this talk about retail investing in the market. This is the natural consequence of these policies as well too.

So, it is going to continue, I think, to foster that inequality because there are some people that don’t have enough money to invest in assets or not enough assets to really matter at the margin. You know, Chairman Powell knows this, I think. It has been very curious that he’s been asked a lot of times, “Do your policies foster inequality?” And it’s about the only time he ever shows any emotion, “Absolutely not! NONE of our policies have ANYTHING to do with inequality. It’s all the virus’s fault. It’s all Congress’ fault. It’s NOT the Fed’s fault.”

Well J., it actually is. You’re the one that’s pushing up financial assets. Financial assets are held by richer people. They’re benefiting from that. You’re trying to tell me and you’ve said this, “Well, if I make all the bondholders rich by holding up their bond prices, then the companies can issue more debt, and then they can expand and hire more people.

So, you’ve already given me the definition of The Wealth Effect, or the inequality that you’re trying to foster as well. So, this is going to be a legacy of it.

The final thought for you, the Federal Reserve keeps telling us about these policies, “Oh, well, we’re going to do this for a while and then the markets will recover and then we’ll get out and we’ll stop.” I heard that twelve years ago. Twelve years ago they said, “We’re going to do this ‘unconventional’ policy of quantitative easing and then once the markets stabilize, we’ll stop doing it. They tried; they ended QE1, as you mentioned; and then the markets wobbled in 2010, and then they did QE2; then they ended QE2 and the markets wobbled, and then they did Operation Twist; then they tried to do the Taper Tantrum and the markets wobbled, and they came back into the market; then they tried to get out again in the 4th quarter of 2018, and the markets wobbled (fell 20% by the S&P 500), and then the turned around and they got back in again. They’re never getting out of this policy.

They’re never getting out. Just like, twelve years later, they never got out of QE, I don’t think they’re going to get out of any of these policies. They’ll try; markets will throw a fit; and then they’ll come right back as well. So, this is going to be, to some extent, until the markets reject them, this is going to be the status quo with the way that they trade.

Moritz

So, they are like a drug addict. It’s like we’re doing those measures in perpetuity but what’s the end game of that? It’s difficult for me to believe that you can just say, “Yeah, let’s do that for the next ten, twenty years. Whatever the case may be, there’s a little bit of a fire, we’ll throw liquidity at it, we’ll extinguish the fire. This is always going to work.” I think at some point there will probably be a natural breaking point where they will lose the trust of the market and then the thing falls apart.

Jim

Yeah, I agree. I’ll offer you an idea of where that breaking point is and that’s inflation. Now, that’s something we haven’t had, to any great degree, at least by the measured numbers or by the market’s perception. I’m clear about those words, “the measure number and the market’s perception.”

When I say, “Inflation,” people say, “Oh, I don’t care what the CPI says, look at the price of this, or the price of that. I see inflation every day.” OK, you may, that’s cost of living, that’s a little bit different than the consumer price index. But more to the point, the market doesn’t see that. But if the market perceives that there is inflation and that inflation starts up, then you’ll see a rejection by bond investors.

There’s one group larger than the Fed and that is what Ed Yardeni coined forty years ago – The Bond Market Vigilantes. The collective wisdom of the bond market is larger than the Fed.

The problem is that the bond market, right now, is not of a collective wisdom. It is not of one thought. There are people there all over the place in the bond market. Some are bullish, bearish, up, down, left, right, forward, backward.

But if you get inflation and then everybody is of the perception that inflation is here eroding the value of fixed-income investments, then they become of one mind and that one mind is to sell. Interest rates go up and then, at that point, the Fed can’t stop interest rates from going up until the market demands that they just stop with the profligate policies.

Now, we’re not there now, and I don’t think we’re going to be at inflation in 2020. I do worry that you might start to see the beginnings of inflation in 2021 or 2022 as well. Then that might become the problem. Why do I think we’re going to get inflation after this cycle, in ’21 or ’22? You’ve got a lot of stimulating of demand. We keep handing people money. Here’s six hundred bucks a week. Here’s a twelve hundred dollar check, go spend that money.

We’ve got a 13% unemployment rate which 3% has been misclassified so, in effect, 16% unemployment rate. Simply put, that just means that, in aggregate, we’re producing less stuff. Not as many people are working as they used to. A fall of aggregate supply stimulating aggregate demand should produce higher prices once we get out of this cycle. Then you might see a rejection of these policies by the Fed.

If I’m wrong on that (we don’t get that inflation), and the policies work (like they would say that they worked ten years ago); that the Fed stepped in and the Fed became aggressive and took over the bond market and started setting prices; maybe [the Fed] even goes all the way to formal yield curve control (price-fixing), and all they would argue to me is “good things happened” (Markets went up, people got jobs, GDP was created, everybody got happy), then why stop?

Why would you ever stop that program? That’s what happened twelve years ago with QE. They never stopped it. I think that this is what will happen this time around. Again, the only thing that will stop it is when the market demands that they stop it and I think that’s inflation, and I think that could be a story for next year and maybe the year after.

Niels

I agree with your point about inflation. I think, actually, it’s a very interesting point. Also, you have mentioned about once the bond market starts to think like one instead of many, as it is at the moment.

I’m still really curious about the motivation of the Fed which, obviously, has received a lot of stick, or at least Powell has, from the White House. Then I came across this documentary a few months ago, The Princes of the Yen, and Richard Werner’s work from the inside of the Japanese money system back in the ’80s or ’90s. At least, based on his work, he felt that the BOJ was kind of engineering the bubble with a goal of getting more independence. Once the bubble burst everyone was unhappy, it would lead to more independence for the BOJ. Could there be any similarities to why the Fed is doing what it’s doing? Could they want more independence? Clearly, it’s not really independent. It’s clearly being influenced by other parties.

Jim

Yeah, if they want more independence they’re going about it the wrong way because they’ve got less independence right now. Let me back up to the beginning of your question. The White House has been criticizing the Fed, but if you listen closely to what Trump’s criticisms have been, they have simply been, “You’re not profligate enough, you’re not pushing the stock market up.”

Right before the pandemic hit President Trump spoke at the Economics Club of New York and he said, “I guarantee you, if J. Powell did the right thing, the Dow Jones Industrial Average would be 10,000 points higher.” Oh, I know what you want here, you want them to force the stock market up and you will then justify it because it will create confidence in jobs. That’s what the big complaint was about the Fed.

Now, the problem is that when the pandemic hit and the economy was tanking, I get it, the Fed can’t just sit there and just start citing obtuse economic theory, they had to do something. So, they stepped in and they did what they could in that they started to massively cut rates, and expand, and start buying bonds, and started all of these programs.

But, the Fed doesn’t have the authority to buy corporate bonds or ETFs, maybe don’t have the authority to buy municipal securities and a lot of these loans that they’re buying. The way that they skirted the rules was the Treasury is technically buying this. They created a special purpose vehicle and the Treasury (the U.S. taxpayer) funds that special purpose vehicle. The Fed acts as their financier and just gives them the extra money. Then the Fed went out and hired Blackrock, on behalf of the Treasury, in order to do all of the trades and a lot of these programs as well too.

So, what the Fed actually did (if they wanted more independence) is that they actually became a division of the United States Treasury Department. They’ve got the least independence, maybe of our lifetime, right now.

This is going to be interesting because (let’s assume Trump stays as President) if the Fed did want to exit these programs they don’t own these securities, the Treasury Department owns these. The Treasury Secretary serves at the pleasure of the President of the United States. It’s unclear, does the Fed need the permission of the Treasury to stop doing this? Or can they just say, “That’s it, we’re done, no more.”

So, they are of one mind. In fact, if you look at J. Powell’s calendar (they’ve released his calendar, now, for April, and his calendar from May will be released next week), but every single day in the month of April J. Powell had at least one conversation with Steve Mnuchin, every single day. I suspect something similar like that will have happened in May as well too.

So, they are the least independent than they’ve ever been right now because they’re so tied up with the Treasury. So, it’s really been… I know a lot of people think that – that the Fed wants to be more independent. They actually went the other way with this.

It’s been a work in process. I don’t know where it’s going to go next. I don’t know how they’re going to extricate themselves from this lack of independence or what it will mean in the future but it will be interesting to watch.

Rob

A lot of people are in preparedness for MMT. So, the central bank should be doing MMT. I struggle to see how that’s different or better than government themselves stepping in and saying, “Right, we’re not going to be able to do this thing of pumping up asset prices and therefore improving the world economy. That’s just not the way things work. We need to intervene directly in the real economy and actually spend money on the fiscal side.”

Jim

I agree. Let me give you a statistic. If the Treasury’s projections and the Fed’s projections are correct, between March and August they are going to, in either a combination of either print or borrow the equivalent of four years of tax receipts in five months. So, they will have created four years of tax receipts in five months to go towards trying to battle the contraction in the economy and the pandemic.

Let’s just for argument’s sake say that it works. We get nothing but good things that happen: jobs, GDP, higher markets, no inflation. There has been an argument that has been made, that I made it too: OK, if you could pull that off without there being any downside (just to starkly get my point across), why do we need taxes anymore? Why do we need an IRS? Why don’t you just print up what we want every year? Congress can decide what they want to spend money on and then just phone over to J. Powell and he can print up the money and away we go. Because if you’re doing it now, and you’re going to do four years worth of it now, and you’re not going to have any bad things, why would you stop? Why would you ever stop doing that at that point?

So, I do think that what the Fed is doing, what the governments are doing, worldwide, with their massive intervention is going to have a profound impact one way or the other. Either it’s going to produce some kind of malinvestment or some inflation (and that’s the camp I would eventually be in), or if it works spectacularly then we have to rethink this whole capitalism thing all over again and ask, “Why don’t we have our central banks and our governments to have a permanent hand in markets, all the time?” If every time they step in and put that hand in there then only good things happen, then why would we ever want them to take it out?

And investors? They’ll just be shortsighted: up is good, down is bad. I don’t care what the policy is but if my stock prices are higher tomorrow than they were today, it’s a good policy. If my stock prices are lower tomorrow than today, it was a bad policy. That’s kind of the only way they look at it. That’s why the Fed doesn’t get much criticism.

I had a Senator once tell me… I asked a Senator once (who was on the Senate Banking Committee), “Why doesn’t anybody ever press the Fed in any of their questions?” He said, “I’ll tell you why (he was talking to me), suppose I wrote down a bunch of hard questions for the Chairman to answer. Suppose I read all those questions and suppose I tripped up the Chairman; the Dow falls a thousand points; I’m in trouble; I’m in trouble for asking the question, not the Chairman for botching the answer, or the policy, I’m in trouble for putting him in that uncomfortable position.”

So, as long as they do stuff, the Fed, even though I think some of these programs that we’re doing with corporate bonds and stuff, might not technically be legal. That’s my opinion and I could be wrong on it. But no one is even going to risk asking the question because they all like the outcome. The market is going up, everything is good.

So, that’s what I said, given all that, I think that the Fed thinking that, “Oh, we’re going to create pleasure for everybody and then we’re going to leave.” You ain’t leaving, you ain’t going to leave. That’s going to be the… Or, you’re going to wind up going too far and creating malinvestment and problems and then the market will demand that you leave because you’re the problem not the solution. Those are the two possible outcomes I see in this.

Niels

Moritz, what are your thoughts at this point?

Moritz

Well, thanks for all of that, Jim. I’d like to, if you guys are OK with that, I’d like to shift gears just a little bit on you, Jim, because I remember one of the conversations that you had with our common friend, Erik Townsend, a couple of weeks back, that related to the oil market and the oil markets. At the point when (I think) you had the discussion, [the oil market] was about to start its massive recovery. This recovery has since continued (probably to the surprise of many, myself included). [It’s surprising] how strong that recovery was and how substantially the contango that used to be priced in the markets has been taken away. Because this is a global macro market, what’s your view on where we’re going from here as far as oil is concerned and as far as supply and demand and the market being balanced and the term structure of that market is concerned?

Jim

Yeah, what’s happened in the oil market has been just extraordinary in what we’ve seen in the last few months. The least bit being the negative prices that we had in the May contract a couple of months ago. A lot of that was a function of financial engineering. It was a function of a lot of these funds that buy the frontend contract and then continue to roll. I think they were at the precipice of creating an oversupply in the super contango that we’ve seen in the market.

Now, since that debacle in May, what has happened with the oil market is a lot of the funds that invest in oil have been largely carried out of the market. The famous one is United States Oil Company the ETF, it was barred from creating or redeeming new shares and they just got approval to do it, again, just like a week ago, and they really haven’t started doing it in any major way just yet. A lot of other funds like the China Oil Fund blew up as well too.

So, what you had happen was, in oil, I think was that you had way too much financial engineering and that’s what you saw in the wild movements in April and May. Now that you’ve wrung off some of that financial engineering, the contango has returned to normal; the price has settled down at around $35 to $40 or so (maybe it’s a little bit above that right now, or thereabouts).

Make no mistake, oil guys, they can rank right up there with Biotech executives in basically making up crap about what they’re doing. Forty dollars is going to be a really tough problem for the oil industry to continue to make money. What I mean by that is that these guys will tell me, “Oh, as long as the price doesn’t go under fifty we’re going to be fine.” That’s what they said at the beginning of the year, or at $65, then it goes to $48, “Oh, we just changed everything, now as long as the price stays above $35…” Wait, how did you fix that in five minutes? The answer is you didn’t.

So, I think $40 is going to be a very tough problem for the oil industry to maintain and you’re probably going to see more cutbacks in production, maybe some bankruptcies. It’s probably going to put a floor on this market right now, assuming that the demand situation is somewhat stabilized and that we don’t have another violent downturn in the economy one more time.

I think what you saw happen, in March and April and May in oil was we had over-financialized the oil market. When the pandemic hit and we had that sharp fall in oil prices and oil demand, oil prices had a hard time adjusting because of all the financialization and then it had to go through all of those wild movements with negative prices and everything else, basically pushing all of the players up and now it seems to be somewhat more closer to normal.

Niels

Yeah, I was just curious (maybe also jumping a little bit around), I think we can all agree that it’s unusual times and it’s certainly some kind of experiment that we are seeing in front of our eyes and it may last for a bit longer. At some point, you would think that something is going to happen. We saw what the Corona Virus could do to markets and maybe something else will happen and at some point (it could be inflation, as you mentioned earlier, Jim), it comes to a breaking point and I’m just curious, in your view, when it does (we don’t know exactly how long that will be), what’s going to be the best safe-haven assets do you think?

Jim

Yeah, that’s a good question. The other thing that seems to be happening in markets is (to the first half of your question), something will come along and, I would actually argue, as we’re talking right now, in late June, something is coming along and that is that, by most metrics you look at, the Corona Virus case count is as bad as it has ever been.

It’s just not bad in London, New York, and Paris, so, therefore, it’s OK. But if you take out those large urban areas that were having a big problem in March, it’s bad. It’s bad in the United States. The United States is showing some numbers that we haven’t seen since early May or late April in terms of the number of cases.

The city of Houston announced, on the day that we’re recording, that they are eleven days away from running out of ICU beds – that it has gotten that bad. Now the reason I say that is the stock market is also continuing to recover. The day that Houston says that we’re eleven days from running out of ICU beds, which New York City, at its worst point never got that bad. Houston, which is the fourth largest city in the country has already eclipsed that in terms of they are in a worse position than New York City’s worst position.

The stock market is recovering. It’s up another 1%. So, what seems to be interesting is, the virus doesn’t matter anymore. I think the reason that the virus doesn’t matter is that there’s this collective opinion in the market (I’m trying to interpret the market), that really what the problem was wasn’t the virus. The problem was the lockdowns. [The markets are thinking], “Now that we’ve gotten rid of the lockdowns, I don’t care how many people get sick, I don’t care how many hospital systems get overrun, as long as we don’t lock down again, we’re fine.”

So, the virus may come back. It may come back in a story that we are of the opinion, especially Houston, Houston is the middle of Texas, the free spirit Texans, the last thing they’ll ever do is lock down Houston. Well, if it comes to that I don’t know if it will, that could actually wind up becoming another real problem for the markets.

Also, there is a myopathy in markets. New York City opened yesterday and they’re allowing outdoor Cafés. So, that’s 80% of the world. New York City restaurants are 80% of the world. So, as far as them, that’s good. Everything is getting better. What’s happening in Houston, what’s happening in Arizona, what’s happening in India, what’s happening in Africa, or maybe South America? Ugh, yeah, that’s different stuff. Well, actually it’s all bad in all of those countries is what you’re seeing in terms of the virus count.

So, the first thing I’d mention is yeah, there will always be something that comes along. Inflation could be one of them. The other one could be that the last word on the virus may not be work. Whether it’s a first wave or second wave, it’s a semantical argument. You hear people say, “What happens if we get a second wave, which they mean an increase of cases, in the fall?” No, it’s happening right now, in the late part of June, and we have just collectively decided that it doesn’t matter right now. It still may, if it comes to that there has to be some kind of change or forced change like a lockdown. That’s what everybody is assuming, that nothing will come of this.

Niels

It’s interesting, right? First of all, I would say that it’s interesting that the market doesn’t price in, right now, the possibility of another lockdown, or not in a large degree because we all know that as soon as politicians and authorities find a new tool that they can use effectively, they tend to use it very quickly in the future. So, my view is, certainly now that we have invented the lockdown, I don’t think it’s the last time that we’re going to see that. That’s one thing.

The other thing is, of course, what about the underlying economy? Are we seeing more travelers? Are we seeing people driving? Is fuel consumption actually showing any signs of a strong recovery? Public transportation, are the trains full? I don’t see it.

Right now, as we speak in late June, as you say, I’m seeing headlines where one of Europe’s, maybe one of the world’s largest airlines is on the brink of bankruptcy if they can’t get this restructuring deal. I’m talking about Lufthansa, in this case, in my neck of the woods. So, there is really a disconnect, in many ways, but of course, that’s what we normally see when these things happen.

It’s like this cartoon where you see people pushing up a train and when the last person jumps into the train, of course, there is no one left to push it any further and that’s when you have the big… So, we need more people to be going from the camp of the Bear to the camp of the Bull, so to speak, just before things can unravel possibly.

Jim

You know, you’re right. Now, as far as where the economy is going, this week is better than last week, next week will be better than this week and worldwide economies are recovering. I’ll even go you one other thing to say that, it is possible that the way that we measure the economy, it is possible that we have already seen the end of the recession in May. But, that doesn’t mean that the recovery is going to be instantaneous. That could be a long period of recovery.

I’ve been making the point, for some time now, that if you look at output, GDP output, using the United States for example, in 2008, at its worst point, the economy’s output was 96% of what it was in the 2007 peak. Real GDP declined all of 4%. That produced a 56% correction in the stock market, 10% unemployment, a lot of angst and anxiety, the Tea Party movement, Occupy Wall Street, and everything else.

In 1929, the worst recession in history, we went to 78% of the output in 1932 that we were in 1929. It was 78%. So, I think that what people need to understand is that I’ve heard a lot of people say, “Oh, the economy is recovering nicely and it will be back to 90% of where it was by the end of the year.” 90%, that’s more than twice as bad as 2008. That’s a near depression.

You have to get back to 96% just to repeat how bad 2008 was. You’ve got to get back to 98% in order to get back to a garden variety recession. So yeah, we are seeing the numbers recover, we are seeing that subway traffic in New York City is now up to 25% of what it was pre-pandemic, 25%. Up from like 4%. We’re seeing airline traffic in the United States is around 21% of what it was pre-virus. We need to get it to 98% in order to say that we’ve really recovered.

If we come up 60%, 70%, and then stall, which would be another doubling if not tripling from where we are right now, that is a bad recession. So, I think a lot of people are not appreciative of how bad this can be for the economy. The thing that they’re focused on now is the rate of change – this week is better than last week; and next week will be better than this week.

So, the hope will continue to say, “It’s getting better.” It is getting better but, if we’ve got 16% effective unemployment you can’t get back to 10% unemployment and just say, “Hey, that’s it, it’s all done, it’s all fixed. I’m sorry you 19 million people that lost your jobs, too bad for you. My stock portfolio is at a new all-time high, and the economy is doing well, yeah for me.”

That is a prescription for disaster if that’s the mentality that we’re going to take. We need to say, “When is the unemployment rate, which is effectively at 16%, going to get back under 5%?” Most people think it’s going to take several years. Ok, what are we going to do in the meantime? Are we going to continue to subsidize everybody for several years with extra money? Are we going to continue to blow these budget deficits out with extra money? Or are we just going to say, “Sorry, you lose, you don’t own stocks, I do.” So, it’s going to be a very difficult thing for us to try and handle.

So yeah, the economy is getting better. There’s no doubt about it, and the worst, the bottom might already be in. But to get all the way back to that old high won’t take a period of a couple of months like old recessions used to, or a quarter or two. It might take several years and that is going to be problematic as we work through this.

Rob

Yeah, it’s interesting, isn’t it, because we’re kind of turning things around, like you said earlier, the bond market’s not really giving a price signal anymore. The equity market isn’t really working efficiently and giving us signals. It’s really interesting to look at the U.S. where there are definitely signs of a second wave with the increase in cases since June. Whereas, in Europe and, say Germany, cases have cracked a little bit from on an extremely low base and yet the Euro stocks are still significantly down from the peak. Whereas, the S&P and the Nasdaq pretty much recovered or have even gone through the previous peak.

But, is there a problem? I’m a big fan, don’t get me wrong, of using this (some people call it) alternative data, this more high-frequency data that you can effectively use to sort of ‘nowcast’ the macroeconomy, but isn’t the problem with using that in a simple way of saying, “Well, we need to get back to the previous peak.” There’s a danger here that there’s going to be structural shifts in consumption and it might be that the long-term normal for, say, traffic, is actually 80% of where we were before rather than 100%. Or do you really think that we are going to eventually move back to where we were, in terms of looking at those numbers?

Jim

No, I do think that that is going to be the problem in that you’re focused on traffic a lot. That may be the new peak is going to be 80%. Well, there’s a simple reason why. I think over half of all gasoline is consumed by people driving to and from work. If this work at home trend continues, and I think it will because one of the things that I’ve argued about what’s happening with the pandemic is, whatever trend is in place, work at home (for one example). You can put them into two buckets. Was it an existing trend that’s being accelerated because of the pandemic? And I think work at home is one that was in place and is being accelerated. Or, was it one that was created because of the pandemic? Well, if it’s being accelerated, it’s going to be very hard to reverse it. I think a lot of people don’t want to say it out loud, but I think they’re very comfortable working at home. I think they like it this way and they would like to continue to have it this way.

Well, if we’re going to drive less, and we are going to need less office space because I think a lot of companies are going to be very happy with that. Look, we were always afraid of the work at home thing because we always thought, eh, people won’t really work. They’ll screw around, but they won’t work. Well, we found out that they do. They do work enough.

Now, I look at my IT expenses at my company and I go, “All my employees are paying for the internet connections. I’m not paying for it. They all have to take it on themselves to do all of their own self IT because there’s no IT guy in their home. If they’re not going to come to the office, I can ditch half my office space and save a lot of money.

So, you can see that becoming the trend, that the larger and urban areas start to shrink because we don’t want to spend the time commuting to go to an office. Of, if we do, it’s one or two or three days a week, not five days a week. That will become a change for the economy. There will be a lot of structural unemployment, there will be a lot of lost GDP that we have built into the economy now because we assume that drivers (to use a number) in the United States consume 10.5 million barrels a day of oil, in driving, which is what they were doing pre-pandemic, not 8.5, which is what they’re doing right now.

Well, that extra two million barrels a day is going to be a lot of jobs and a lot of GDP lost. A lot of those office spaces are going to see their leases hold come up and there’s going to be a lot of give back of office and they’re going to have a lot of glut of office space. There’s going to be a lot of people that, maybe, if I can work at home, and home can be anywhere I want it to be, then why don’t I become like Niall Ferguson (the economist at the Hoover Instituion), who has moved to his house. He famously said, “Look, I’ve moved to my house in Montana. I haven’t wandered more than five miles from my house since March and I’m fine with that. I could just stay this way forever, as far as I’m concerned.”

So, if I’m going to work at home let’s go big, and let’s sell our house in suburban New York, or Manhattan, and let’s move to the backwoods of Vermont or Montana, or where ever you want to move. So, you could see a massive change in the economy. That will take years; that will create disruption; that will create problems in the economy that will be much longer term. A lot of people will feel left out and it won’t be that simple.

So yeah, when I hear the President or Larry Kudlow say, “Well, the economy is going to boom right back to where it was in early 2020 or 2019.” I don’t know if we’re ever going to go back. I’m not saying it’s going to be bad, I’m just saying it’s going to be different. I just don’t think you just go back and close your eyes and imagine what things were like last summer and say, “We’re going to go right back to exactly that spot.” Even J. Powell somewhat seems to hope for that too, “We’re going to go right back to where we were last summer.” GPD output may get there over a period of time but that’s only after we’ve restructured to this new kind of thinking that was catalyzed by the pandemic.

Niels

Just before Moritz, maybe you have, I’m sure, a question. I just want to add one thing to this particular point and that is, to me (and I want to hear your thoughts about this as well, Jim, because you know much more about these things than I do), it almost seems to me that this could be one of those paradigm shifts that we’re entering into. I’m not saying that it’s the Corona Virus that’s the fault, but what we’ve generally seen, in a bigger picture, is you’re seeing people working for car manufacturers, people, as you say, working in the fossil fuel production. We have transportation where technology is disrupting that with driverless this, that and the other.

It seems to me it’s almost like what happened to the farmers a hundred years ago, where it went from being 25% or 30% of all people were employed in that sector and suddenly there wasn’t much use for them with technology and other changes. Now we’re down to 2% or 3% of that. As you say, it has massive consequences. Actually, right now, I wouldn’t know where these people would go to find another job because that’s what technology does. It also, actually, limits the amount of people that you need to produce more stuff.

Jim

Yeah, there’s a professor at Northwestern University suburban Chicago, Bob Gordon, and he’s done a lot of work on productivity in jobs and his conclusion, which I largely agree with, has been that jobs, technology, is a net creator of job. To use the famous example that he’s been using, VisiCalc invented the spreadsheet in 1979. Well, that meant the death of the accounting clerk job. Hundreds of thousands of accounting clerk jobs were eliminated. But it created a whole new class of jobs called the financial manager. We created more people using spreadsheets to analyze data than we eliminated people whose job was to just type data into a computer.

So, it is a net creator of jobs. I do believe that, over time. But here’s the problem, when something like autonomous driving comes in, it’s really simple and it’s really easy to see who loses. The driver loses. We worry that they tend to be lower-skilled, what are we going to do with them? Then we get calls to wring back and not have that technological advance, slow it down. But it will create whole new industries and whole new jobs. I don’t know what those jobs are. Maybe you don’t, nobody does.

I’ve said that when Steve Jobs, in 2006, held up the first Apple 1 iPhone, how many people looked at that phone and said, “Wow, that’s the end of the taxi business because it will create Uber. Oh, wow, that’s the end of the hotel business because we’ll create AirBnB,” because of the whole thing with the App Store and these new phones. Nobody saw that coming. It kind of organically happened. You give people these opportunities and they create them.

So, we will create new jobs. We just don’t know what they are. The old jobs will go first, the new jobs will come later, the old jobs we know what they’re going to be that are going to be lost – the driver job. We don’t know what the new industries or new jobs are going to be created because of driverless cars. So, I’m not afraid of the future happening in that respect, but I understand the anxiety and the stress that it’s going to cause to get there. It might even cause a retarding of the economy because the old jobs go first. We won’t create anything except that we’ll just get rid of drivers and let cars drive themselves. Then, when we start realizing the cost of transportation has gone down so much, whole new ideas on what you can use transportation for will be created and they will create new jobs going on.

The internet with the invention of blogs illuminated a lot of newspaper jobs, or a lot of reporter jobs, media jobs. But the whole blogging industry created a lot more opportunity than the jobs that were lost. But, that will take time to go from one to the other. It’s not seamless. It’s a little bit chaotic and a little bit messy. But I do think that will be what comes of it. So, it will be a difficult transition but we’re going to have to make that transition. I just don’t see how we’re going to go back.

The pandemic? You’re right, it may not have created any of this, but what it did do, I think, is accelerated some of these trends and we’re going to see a bigger acceleration of some of these trends, Maybe a deurbanization; maybe a work at home type of thing, those kinds of ideas I think we’re going to see more of that as we move forward.

Moritz

Great Jim. We want to be conscious of your time. We’re just about above an hour, but I guess the million-dollar question that I wanted to bring up, and we didn’t even speak about gold yet, but given all that we’ve just discussed, how would you think one should allocate or structure their portfolio in order to be best prepared for what’s to come?

Jim

Well, that’s a good question. Short-term, I think risk assets are going to do better, in the short-term, because I think that the pull of central banks and governments trying to reflate markets is going to stay strong and it’s going to be tough to fight that. So, it’s going to go up.

Longer-term, you’ve got another six months, maybe a year, maybe three [months] – three months to a year of decent markets, would be my guess. Longer-term I fear that this is going to create a malinvestment and inflation that’s going to have financial markets struggling thereafter. The inflation, when you ask, so, I think that risk markets will then struggle.

As far as interest rates go, they’re going to stay range bound and they’re going to stay kind of tight to where they are right now with a slight upward pull because I think that inflation in the future might be a slight upward pull but not a big upward pull. So, there’s not going to be a whole lot to do in the bond market. And if you use it as a risk reducer, like in a 60/40 portfolio, I don’t think it’s going to work as effectively as it used to in the past.

Gold, you asked about gold. I’ve always argued that gold and cryptos kind of go in the same camp. How do you get your money out of the financial system? Well, there’s really no good way to do it. The closest way we have is gold or maybe cryptos. But here’s the problem with gold. It’s still so tied to the financial system because people say, “Do I buy gold?” And I say, “Yes.” And they say, “Good, I’ll go buy some GLD.” Well, wait a minute, the reason you want to buy gold is that you think there’s going to be inflation, or there’s going to be some kind of a problem and that you want to have gold as a hedge. But if you’re going to run right into GLD then go buy Tesla because it’s the same thing. You’ve still got your money in the financial system. Go buy some coins and bury them in your backyard. Nobody knows how to do that so they don’t do that.

So, I think I’m mildly bullish on gold. I think gold should be going a lot higher. But we so financialized it between ETFs, and futures, and derivatives that it’s so tied with the financial system. Look at what it did in March. When everything got really ugly, which is the time you’re supposed to own gold, it sold off, because it also has an element of being a financial instrument too and it sold off with everything else. So, I’m mildly bullish on gold. If there was a way to really separate gold from the financial system I’d be a lot more bullish on it than now. So, short-term risk markets go up, longer-term I feel that they’re going to hit a ceiling and run into trouble after three months to a year. I think interest rates are going to meander sideways. I think for those in a 60/40 portfolio that think that that’s their edge, they’re going to be disappointed by it. I like gold, but I’m kind of mildly bullish on gold, I’m not wildly bullish on gold right now.

Niels

Well, Jim, on that note let’s wrap up our conversation being mindful of your time. Thanks so much for spending a good hour with us. We really appreciate it and I’m sure all of our listeners do as well. By the way, to all of you listening today, make sure you follow Jim’s work on Twitter and at Bianco Research, of course. 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.

Thanks for listening to Top Traders Unplugged. If you feel you learned something of value from today’s episode, the best way to stay updated is to go on over to iTunes and subscribe to the show so that you’ll be sure to get all the new episodes as they’re released.

We have some amazing guests lined up for you, and to ensure our show continues to grow; please leave us an honest rating and review on iTunes. It only takes a minute, and it’s the best way to show us you love the podcast.

We’ll see you next time on Top Traders Unplugged!