Preston Pysh  1:19  

Jim, I want to hop onto the thing that I personally enjoy talking to you the most about. That’s just central banking in general, because each time you come on the show, you just always have such a wealth of information to give people a little bit of foresight as to what they can expect in the coming quarter and in the coming six months. 

What I would ask you is, what are you hearing? What’s the story you’re hearing today with respect to quantitative tightening and the federal funds rate? What’s the word on the street?

Jim Rickards  1:51  

It’s topic number one, whether you like the Fed or not. The fact is they sort of run the world. People know the basic statistics on the dollar. It’s about round numbers. It’s about 60% of global reserves. It’s about 80% of global payments. It’s about 100% of the oil market. Not quite, but close to 100%. 

You just look at those numbers and you go, “Wow, the dollar dominates.” It gives the US a huge political weapon, a huge actually a military weapon, because a lot of the payment system has been weaponized. This is how we impose sanctions. You hear about sanctions all the time. 

Why don’t we actually do sanctions? Well, one of the ways we do it is we kick you out of the payment system. We freeze your accounts to seize your assets. We do secondary boycotts. So if you’re a Swiss bank or French bank and you do business with someone who’s the target of our sanctions, for example, Russia or North Korea, we will kick you out of the payment system. 

If you’re at UBS, Credit Suisse or a Deutsche Bank, you don’t dare go near any of our adversaries who are being sanctioned even if you’re not doing sanctions yourself, because you’ll end up on the wrong side of that. Therefore, it’s a very powerful weapon, but even what I just described does not capture the full extent of the dollar power because there’s so much that goes on behind the scenes. 

Actually, the Bank of England just had a new report on this. This gets into the world of currency swaps. A currency swap is simple, but unbelievably important because the US is even more leveraged than most people realize. 

For example, just go back to the 2008 financial crisis. What was at the heart of the crisis? It started with mortgages, but that wasn’t really why it got so bad. It was the contagion effect. It has spread to government securities, junk bonds, corporate stock, international *inaudible,” it has just spread in every direction.

However, one of the biggest problems was the European banks made more money lending dollars than they did lending euros, Swiss francs or any other currency. Well, if you’re the European Bank, and you’re going to lend dollars, you have to finance the dollars. You need dollar liabilities to go along with those dollar assets. 

One of the things they did was issue commercial papers. They had deposits. They issued commercial paper and there was a huge appetite in the US money market funds, which bought US dollar denominated commercial paper from European banks. 

Well, when Lehman Brothers failed, a couple of money market funds failed right around the same time. All the money market fund operators refused to roll over that European Bank commercial paper. They said, “Hey, Deutsche Bank, we’re not going to take any more of your paper or Unicredit or UBS, any of the others.”

When any commercial bank is in that situation, they turn to their central bank. The central bank is the lender of last resort. However, the problem was the ECB doesn’t print dollars. They print euros. These banks needed dollars. The Fed prints dollars, but they weren’t the principal regulator. So what did they do? The Fed printed up $5 trillion and the ECB printed up 5 trillion euros or equivalent. Then they swapped. All of a sudden the Fed has all these euros. The ECB got the dollars.

At that point, the ECB was able to lend dollars to the European banks to bail out the European banking system. So not only did the Fed bail out Wall Street, and indirectly bail out General Motor, Chrysler and General Electric in the entire stock market and all the US institutions. They also bailed out the European banking system through these swaps.

Since then, the swap arrangements have proliferated. The US has about 20 or so partners among major central banks, including obviously ECB, Bank of Japan. Many others like the Central Bank of South Korea and kind of our allies and friends throughout the world… China has put some of them in place. 

China has a swap arrangement with Switzerland regarding Swiss francs and Chinese yuan. The point is these foreign central banks are even more dependent on the Fed than people realize because the swap ranges which are off the books do not require any congressional approval, etc. 

The dollar is not King Dollar anymore. It’s more like an emperor. *inaudible* said that my view has been for a long time that that system is more vulnerable that people realize. Whenever you’re that powerful, you’re just going to cause a reaction. That’s the action King Dollar, but the reaction if you’re Russia, China, or for that matter, North Korea, Iran, Turkey or any of these other countries, you’re sitting there saying, “Okay, I get it. What can I do to work around the system? What can I do to create an alternative? How do I get out from under dollar hegemony?” 

They’re very far down that road. Russia and China are building their own internet that’s not connected to what we regard as the Internet of the World Wide Web. They’re stockpiling gold. We can talk some more about that. They’re working on cryptocurrencies. I’m not talking about Bitcoin. They’re working on their, a so-called Putin coin or Xi coin, whatever you like. 

They’re getting close to rolling out a system that would work a little bit as follows. So Iran could buy missile technology from North Korea. Russia could buy infrastructure from China. China could buy weapons from Russia. Iran could buy weapons from Russia. Russia is a big export of nuclear power plants. Turkey’s a good intermediary, a big tourist destination as a big part of their economy. The big one would be China buying oil from Iran. 

See of all these bilateral trade relations going on, all of a sudden you don’t price them in dollars, because oil and some of these other things are prices that you don’t price them in dollars. We price them in these new coins. They could have a stable value. One coin is worth one SDR. You don’t have to use the US dollars as your anchor. Then you just keep score. For example, “I ship stuff to you. You ship stuff to me. One of us owes the other at the end of the day.” 

Periodically monthly, quarterly twice a year, it looks at the scorecard and you settle up in physical gold. You can actually move the gold around. Put it on a plane and fly it. As I said, move gold, there’s no wire transfer, nothing digital, nothing to hack. 

So all of a sudden, you’ve got this whole system. You’ve got an alternative currency that’s backed by gold. The gold would only have to move on a net basis. That’s the key. You wouldn’t have to move on a gross basis. On a net basis, you’d keep score with these coins, but on a net basis, you would just convert it to gold or some SDR rate and settle up. 

What’s important about that system is there are no dollars involved. You can’t sanction it. You can’t hack it. You can’t shut it down and the world moves on without the dollar. 

Is the dollar extremely powerful? Yes. Has it been weaponized to pursue foreign policy goals, military goals? Yes. But like any powerful weapon, it invites a response and that’s in the process of happening. Therefore, very interesting times in the years ahead to see this play out.

Preston Pysh  7:56  

When I look at the actions that we’ve all seen from the Fed recently, we had the big Christmas drop in the stock market there and Christmas Eve. I mean, it was down 20% very abruptly. You saw surprisingly Powell through that drop was really not indicating that he was going to change course in any direction. Then right there at around Christmas time, maybe slightly after Christmas time, you had everyone in the equity market just squealing as to the pain that they were feeling.  

I think a lot of people are looking back to previous cycles and saying, “Hey, at this point in time, the US Central Bank was starting to ease.” What is your take on some of that maneuvering? Because as soon as that happened, and we saw the market, this has to be one of the biggest bounces I think we’ve ever seen in the US stock market. It’s probably bounced 17% or something like that.

Jim Rickards  8:46  

The backstory is very deep. It involves a lot of wordsmithing, psychology, head *inaudible*, but let me just give you the quick version of it. We all know what happened in 2008-2009, QE1, I don’t think they did it the right way but it had to be done. That is the central bank’s job. You are the lender of last resort and no one really argues with QE1. 

I personally would have been a lot tougher. I would have nationalized the banks and cleaned up the balance sheet, stripped out the assets, put them in trust for the American people, sold them off over 20 years, and then IPO the clean dice. 

You don’t want a government and banking system that can be privately held, but he had to clean it up. However, QE2 and QE3 were different. I was on CNBC in August of 2009-2009, literally just six months after the depth of the crisis, which was March. Three months after the end of the recession, there was a Fed meeting coming up and then we showed *inaudible* and asked her what they should do. I said they should raise rates since 2000. It’s just a little 25 basis points. You don’t have to do a whole sequence. Just to let the world know we’re going to get back to normal. 

They did not do that. They didn’t raise rates until 2015. Six years of zero interest rate policy and then QE2 and QE3. Now the important thing to know about that is it is completely unprecedented. We’ve never done anything like that in the history of the United States, in the history of the Federal Reserve. From 1913, they had never done anything like that. This was an experiment.

I talked to Bernanke about it. He is a great admirer of FDR, Franklin Delano Roosevelt, and as a close student, he sort of made his academic reputation on setting the Great Depression in the footsteps of Anna Schwartz and Milton Friedman. 

What he admired about Roosevelt, Roosevelt was no economist but he was always willing to try something he’s like doing something was better than doing nothing. Was he just gonna sit there and let the recession or let the Great Depression somehow unwind itself? Who’s going to do something if that didn’t work? Can we do something else? 

Now that’s the opposite of the Hippocratic oath in medicine. First do no harm. Doctors don’t do anything unless you know what you’re doing. They can’t see how it did much good. It didn’t necessarily do a lot of harm, but it didn’t do much good either. Most of the action was not in GDP, not in rising wages, not in strong economic growth. 

The action was inflated asset values. The money goes somewhere. If it’s not going into consumer prices and velocity, it is going into asset prices. That’s what happened in real estate stocks. So they got that reflation, if you want to call it that. 

Now they got to 2013 and they said, “Okay, now we have to get out of this.” They painted themselves in the corner. How do you get out? That was the taper talk. That was sort of a near meltdown of emerging markets, just the suggestion that they were going to do it. 

So September 2013, everyone’s ready for the liftoff. It doesn’t happen. That was in response to this meltdown, but it did happen later that year. They started the taper and finished a year later in 2014. 

Now you’re ready for liftoff, which is the first interest rate hike. That didn’t happen until December 2015. They then started a tightening cycle, but the whole time for 2009 even until today, 2019. We’re almost 10 years into this expansion.

Average growth, annual average growth and GDP over the last 10 years has been 2.24%. All the recoveries since 1980, the average is 3.24%. It’s a full point higher. This is why I call it a depression. This is using John Maynard Keynes definition. A depression doesn’t mean the GDP is always going down. That’s not going to happen. 

Depression means that you have depressed growth. Your actual growth is below potential. It’s below trend. If you think one percentage point doesn’t sound like a lot, it is. In a $20 trillion economy, take a point off for 10 years, you’re talking $5 trillion. $5 trillion of wealth left on the table. 

Imagine someone walking into the Oval Office today handing the president a check for $5 trillion and saying, “Mr. President, do what you want with this for the good of the American people.” That’s how much wealth we’ve lost because of this depressed growth and they still can’t get out of it. 

Why was the Fed, even though I thought they should raise rates in 2009, why were they scared to death to raise rates in 2015 and 2016? They wanted to. They wanted to raise rates. The path the Fed is on now again, as I said before, it’s completely unprecedented. Why would you raise rates in a weak economy? 

Well, normally you wouldn’t, but they have to get rates high enough so that when the next recession hits, they can cut them. This is like hitting yourself in the head with a hammer because it feels good when you stop. So how much do you have to cut them to get every recession? 

Well, economic history shows a long time series that it takes four to five percentage points of cuts to get the US economy out of recession. Let’s just take the low end, let’s say 4%, 400 basis points. How do you cut 400 basis points when you’re only at 225 basis points, two and a quarter percent? The answer is you can’t, but you’re not close. 

If we go into recession and I’m not predicting it, the economy’s weak, but we’re going to have recession sooner than later. If they can’t get raised to 4%, 4.5%, or 5%, they’re not going to be able to cut them enough to get out of a recession. Then what do you do? 

Let’s just say it happens. You borrow and you cut them from two and a quarter back to zero. What do you do next if you’re not out of the recession? QE4. That’s exactly right. By the way, that’s the reason they’re reducing the balance sheet. That’s the reason they started QT, quantitative tightening. 

During QE, there was a very famous cartoon image of it was Ben Bernanke with a manic look on his face, hanging out of a helicopter holding the *inaudible* with one hand and throwing out hundred dollar bills with the other hand. I’m sure you’ve seen it on the web or whatever. 

Well imagine a new cartoon. It’s a furnace with a stack of hundred dollar bills and Powell sitting there with a shovel, throwing the money into the furnace. That’s what he’s doing. That’s what QT is. We do space money, reducing M zero. 

Somehow we’re supposed to believe that printing money was good for the economy and inflated asset values, but burning money is not going to take the asset values down? Of course it will. So why are they doing it? Well, they’re doing it because they want to get the balance sheet down, so they can go back up again in QE4. 

They want to get interest rates up so they can cut them again in the next recession. They’re trying to reload the gun or fill up the toolkit as the case may be to get ready for recession. The conundrum is how do you get ready for the next recession without causing the recession you’re trying to cure?

Stig Brodersen  14:53  

Now Jim, I’m looking at this chart from *inaudible* research group and it shows the aggregated global level of the central bank’s balance sheet. That was growing as one might expect after QE1. Then what you see here at the end of 2017, when the Fed was starting to tighten or burn money as you refer to, then you saw the global balance sheets contract. Then, what you recently have seen is that it’s going in reverse. The US is not, but we have the ECB and the Bank of Japan that are back in print mode. Do we expect this trend to persist? Why is it important for us as investors to track the progress?

Jim Rickards  15:34  

This is going to persist. The thing that’s important to understand about QEs is that there’s a very important behavioral and psychological component to it. Here’s what I mean by that. The Fed path starting in 2015, has been raising rates four times a year, 25 basis points each, every March, June, September, December, like clockwork until you get to this target of say 4%. 

However, they do pause. They have paused occasionally. What are the conditions under which they pause? This is why actually forecasting central bank policy is very easy. Your baseline scenario is four times a year like clockwork for at least 2021. So the trick is well, okay, but we know they pause. Yes, they do. What are the conditions under which they pause?

One is disorderly markets, when you have stock markets, not only going down, but going down in a way that risks are getting out of control and building on itself going down. 

The Fed doesn’t care if the market is going up 15% in six months, but they do care if it goes down 15% in three or four weeks. That was the kind of drawdown we were saying last fall, as you correctly described it up until Christmas.

The other one is very powerful disinflation or even deflation. Their target is 2%. They use core PCE year every year. So personal consumption expenditure, core prices year over year, that’s their benchmark, and they’ve set it at 2%. 

Well, if it’s 1.9, they figure they’re close. They worry about it, but if you see that going down… Right now it is going down 1.9, 1.8, certainly a year and a half ago was down as low as 1.5. That’s enough to get them to pause.

The third element is if job creation dries up. Well, look at the scope. Job creation is strong and continues to be strong, despite the government shutdown and some natural disasters, a lot of other things too. Job creation is strong, so that they’re okay with that. The price deflator has been pretty strong, but it’s up to 1.9 to get to like 2. They’ve been at 2 for one or two months in the last six years. They have not been sticking the landing, but it’s been close enough. 

However, the thing that spooked them three times in the last four years is a disorderly market. We saw this in September 2015. So the Fed did not raise rates in September 2015, why? The US stock market declined 11% in the last two weeks of August. That was the shock Chinese devaluation and US stock markets fell completely out of bed. 

I don’t know where people were on Labor Day weekend in 2015, but a lot of people had a sick feeling in the stomach. It looked like there was no bottom. Then the Fed paused, then the market turned around because of foreign fees. Then they finally did raise in December 2015. 

No sooner was that done, then we had another stock market collapse from January 1 to February 10, 2016. Stock market went down 11%. Again, that was also caused by Chinese devaluation. The Chinese hadn’t learned the lesson. 

In March, the GE20 finance ministers met in Shanghai. They cooked up the Shanghai Accord, and the Fed did not raise rates in March of 2016. Again, that was a reaction to a disorderly market. So they do this occasionally. Of course, they’re not going to raise rates in March. That’s pretty much baked in the pie. We’ll see what happens in June.

However, they haven’t cut rates. What does it mean to ease? What it means is your expectations they’re going to raise, but then they let you know that they’re not going to raise and relative expectations, that’s a form of ease. But look at what’s going on here. It’s a psychological game. They don’t actually cut rates. They don’t want to give any of this back because they still want to get to 4%, but they don’t want to cause a recession. So they will ease when they have to.

I happen to have some one-on-one conversations with the guy behind the scenes on all this. He’s not a member of the Board of Governors, but he might as well be. He’s been tapped three times by Bernanke, Yellen, and now Powell. Every time he tries to go back to his day job, the Fed calls him back. 

He does the wordsmithing. When I say wordsmithing, I don’t mean writing the press releases, I mean, especially encryption or code words, and everyone’s picked up on: “patience.” But if you go back to March 2015, that was when the taper was over. We were getting ready for the so-called liftoff. Then Janet Yellen gave a press conference and they issued a statement. She did not use the word “patient.” 

If you look at all the prior FOMC statements, the word “patient” was there. Patient was code for “we are not raising rates until further notice. We will let you know when we will,
which means risk on. You can do the carry trade. 

When you do carry trade, you’re shorting the dollar. You’re borrowing dollars and you’re investing in something else. That means you’re short dollars. How do you lose money in that? Well, you can do a carry trade leverage and tend to want to make nice 20% returns on equity, but you’ve had a bombshell when the Fed raises rates because all of your short positions are going to go underwater very quickly. Your cost of funds is going to go way up. 

When the Fed uses the word “patient,” they mean we’re not raising rates until further notice. You can do the carry trades safely, you can be risk on safely. Go out and make some money and will signal you. How did they signal you? 

This is what happened in March 2015. They leave out the word “patience.” Then that says, “Okay, we’re going to possibly raise rates at the next meeting, maybe the meeting after that. But if you get caught on the wrong side of the carry trade, shame on you, because we told you what we’re going to do. You got your warning with at least three months, maybe six months to respond.”

Now, I think a lot of people have picked up on this. Going back four years and that they’ve been using this word “patient” exactly as I described it. It’s code. Now lately, everyone’s picked up on it and Bloomberg. Everybody’s like, “Oh, they use the word patient.” Well, yeah, they started doing it five years ago. It is a signaling mechanism. So if they use the word patient in March, that tells you they will not raise rates in June. 

If they leave the word “patient” out, it doesn’t mean they will raise rates in June, but it means that they might say the same, the coast is clear. However, it’s all driven by the same thing, which is they have not given up on raising rates. 

There are some people I respect and they say, “Well, the next Fed move is going to be a rate cut. We don’t know when, but probably by 2020.” I say,  “No. They’re going to pause. They’re not going to raise rates until further notice, but they have not given up on this bigger goal of getting rates up to 4%. They have to. Otherwise they can’t fix the recession.”

Stig Brodersen  21:31  

Keeping your response in mind and knowing that the other central banks, including ECB and Bank of Japan, like we talked about, they’re losing their monetary policy. The US is holding firm, perhaps even contracting a little. What is the future implication of the situation right now in regards to the US dollar?

Jim Rickards  21:48  

What we’re seeing is the continuation of the currency wars, not unlike the 1920s and 1930s, where it was really cutthroat. Bernanke reinvented currency wars as a game of pass the canteen. We’ve got five Marines there solely in position. It’s 100 degrees out. They’ve got no water. They’ve got one canteen. Each guy would like to drink the whole canteen, but they don’t take a sip. The next guy takes a sip and you pass it on. That’s how Bernanke reinvented the currency wars. 

The US is looking around the world. We’re a global player, of course, and Europe looks very weak. Japan is either in a recession, actually, Japan is in a recession. Germany’s flirting with recession. Italy’s in a recession. I mean, we’re complaining about 2% growth versus 3% growth. It’s a big deal.

However, these other countries I just mentioned, including some of the major economies in the world are looking at actual recessions. China, which is not quite in the cloud, but they’re obviously the second largest economy in the world. They’re an important player, their growth is slowing down.

Now, they have such high growth, that they’re not in a recession. But when you take China from 10% to 6%, that’s a big deal. I mean, the second largest economy in the world, about 15% of global output and you slow them down by 20%, going from 10 to eight or eight to six or more, that’s a big deal, That really hurts global growth. 

The whole world is slowing down. The US is if it’s not quite the little engine that could, at least the only source of growth so what we say is, “Okay guys, here’s the deal. We’ll have a stronger dollar. You weaken your currencies. You ease. We will tighten, or at least just stand still and you go with easing policies. You’ll get a cheaper currency. That will help your exports pay some jobs. Give you a boost. Maybe it comes out of our pocket a little bit but it’s not in our interest to see all these other economies start another financial panics.”

You’re exactly right. It means a stronger dollar or at least continues to strengthen the dollar. We already see a weak euro and a weak yen. The yuan is a little different because there is a political factor there. That’s a weapon in the trade wars. We haven’t really talked about the trade wars but China has entered a trade war with the United States so the last thing they want to do is cheapen the currencies, promote exports. It has enough to make *inaudible* go ballistic. T

hey won’t do that, at least in the short run, but in the longer run, I expect they will. So yeah, the dollar strength is going to maintain not because we like a strong dollar but because if we don’t give those other guys a break, if we don’t pass the canteen, the world is going to be in a much worse place.

Preston Pysh  24:09  

When we saw this dynamic play out starting in 2015, where the ECB started easing like crazy, because at this point, you could maybe argue this is where the US stopped drinking from the canteen and then handed it over to the ECB… The market in Europe from 2015 up until like the late 2017 timeframe, the equity market went bananas over there. With the US in a tightening position and the ECB kind of demonstrating that they might be loosening, or least loosening heavily relative to the US, is the European equity market a good place to be?

Jim Rickards  24:49  

You have to be selective. So the short answer is yes, with the ECB definitely not tightening any time soon. Still de facto easing, maybe extending long term asset purchases longer than expected. Japan’s easing like crazy and their people say, “Well, yeah, your rates are below zero you have negative rates. How can easing give you any more relief?” The answer is cheap is the currency. That’s how Japan’s getting a boost.

The Chinese are easing like crazy. By the way, everything I’ve said about the Fed, take all this other central banks times two. They’ve printed more money, more essential bank leveraged sheet balance, more ease. So China is easing. Japan is easing. Europe is easing or delaying tightening, same thing in effect, all very aggressively. In theory, it’s good for European exporters. So it’s good for heavy equipment manufacturers, arms manufacturers. It’s good for tourism. It’s good for certain sectors. 

But then again, with global supply chains, you may be an exporter, but you’re probably importing your components. So if you get a little more exports based on the cheap currency, remember you got to pay more for your inputs. 

The other thing that’s going on is that because of the US-China trade war, and the impact that has on China. A lot of the impact is playing out in Japan, because Japan sells a lot of stuff to China. 

See everyone looks at China as this export powerhouse. Well, yeah, in gross terms. However, in net terms, when China exports an iPhone, they get the glass in Japan, they buy the processor from South Korea. They buy other components from Germany, and then they just assemble them. So the Chinese value added in the iPhone is like 5%. 

The people making the money are the Japanese, Chinese and South Koreans. Well, if you put on tariffs, and you slow down Chinese exports to the United States, the real people who suffer are Japan, South Korea and Germany because they have the high value added exports that go to China for the assembly process. By the way, it goes into recession. Japan, Germany, and we just saw the South Korean market implode because of the truncated talks with North Korea. 

Again, it’s complex. Needless to say, you can almost never look at a country in isolation. You can talk about policy and policymakers but if you don’t connect the dots… Let’s say well how does what the US has done with China affect Germany or Japan or South Korea, the countries I mentioned? You have to take the thread all the way back to see the impact of this. But the big picture is the US is deeply concerned that the entire world is into recession. 

You remember a little over two years ago, 2017, remember Christine Lagarde of the IMF talking about global synchronized growth and every elite, like Davos, IMF meetings, G7, global synchronized growth at last. We were waiting for this for nine years. It lasted about six months. Now we’re getting global synchronized slowdowns or outright recessions in every country I mentioned including the US.

By the way, just a quick footnote on the US because we just saw the fourth quarter GDP numbers come out the other day. 2018 was supposed to be the year of 4% growth and the recession is over almost 10 years ago. That’s not the point but we were stuck in this depression, depressed growth all the way along.

Well, the second quarter of 2018 GDP growth annualized every year was 4.2%. Everyone said, “Happy days are here again.” Third quarter was 3.4% still strong, but down significantly the fourth quarter is 2.6%. Not horrible. But look at that trend: 4.2, 3.4, 2.6 What does that sound like? 

Sounds like we’re going right back to the 2.24 9-year average. In others we had a little pop. I hate to use cliches. You hear sugar high a lot. But yeah, that second quarter number, that was a direct consequence of the tax cut. Trillions of dollars coming back to the US. It was here along, by the way, just invested treasury bills. Now they can be free to do stock buybacks and a lot of companies wouldn’t give you a raise but they would give you a $1,000 bonus or whatever. 

So we got a pop that didn’t last long. Fourth quarter was weak. Looks like early weed in the first quarter of 2019 will be even weaker. Car sales fall off a cliff, retail sales are down. So the first quarter might be you know, 1.6-1.9% it’s not the end of the world but we are back in this trough that the Trump track record over two years-old looks like the Obama track record. 

During the eight years of Obama, we had some 4% quarters. We had more than one and we had a couple quarters over 4% back to back. However, what happened is they very quickly went back to 1.5%. When you averaged it out over the entire time, it came to as say, 2.24%, which is very weak growth. It looks like we had a couple of good quarters in the middle of 2018. We’re right back in the trough, no reason to believe that we’ve escaped it. 

Of course, are we getting a tax cut in 2019? No, we had it. So now the year-to-year comparison starts to suffer. People are paying higher taxes and they thought because of the state local tax deduction… We don’t have to tear that all apart, get into the details, but the bottom line is it was a one time pop. We got it. It’s over. We’re back in the trough. Nobody has a solution for this. 

Meanwhile, if you take, say 2.5% real growth and throw on 1.5% inflation, that gets you to 4% nominal growth. How much is the debt going up? 6%. Soon on its way to 7%-8%. We’re just digging a deeper hole.

Preston Pysh  30:09  

Yeah, this was the thing Jesse Felder was telling us. He’s like never have you been at the top of the cycle and seeing these dynamics kind of playing out at our gas. We’re accumulating debt. 

We had Howard Marks on the show. He said something really interesting to Stig and me. I just forget how he phrased it but he effectively said, “I think that this cycle is going to be not as pronounced as ones we’ve seen in the past, and it’s going to be like this big giant movement as far as the business cycle.”

Then I’m hearing an interview where Ray Dalio is talking about his opinions on the credit cycle. He suggested that this is going to be kind of a longer drawn out process. When you look at the coordination from a global perspective of all these central banks, coordinating the management of how they’re inflating all this fiat currency…

Jim Rickards  30:57  

Ask yourself, would you rather have five-year expansion with 3.5% growth all by six month recession with negative 1% growth. Then another five year expansion at 3.5%. That’s scenario A.

Scenario B is a 10-year expansion with two and a quarter percent growth. The first example gives you higher total growth, and you quickly get back to trend. By the way, that’s the history of most *inaudible, watch all the recessions other than the one in 2008-2009, since the end of World War Two. Yes, you do have recessions. You do have a business cycle.

From 1983 to 1986, during the Reagan administration, real growth was 16%. We were banging it out 5% a year real. So we had a 60% growth in three years. Then okay, 1989 a recession came along. It was fairly shallow. Then 10 years ago, at the end of the Bush administration and eight years of Clinton, then another fairly shallow recession in 2000. So these are normal business cycles and normal levels. 

What’s important about all of them is you fall into recession, but you spring back with a lot of strength and you get back to trend. It’s like a great runner who trips and gets up but still a great runner. It keeps going at a record pace. 

That’s not what happened this time, because the 2008 panic and recession were so bad. The worst since the Great Depression. It was so bad that they couldn’t let it play itself out. It may play itself out with a *inaudible*. Citibank was nationalized. Goldman Sachs was nationalized. So that didn’t happen. They truncated it. 

Well, the problem is there’s a cost with central bank intervention to truncate. The cost is if you don’t hit the bottom, you never get the bounce back. If you don’t let the B go all the way down, and Bernanke wouldn’t you don’t get back to trend. What happens is it’s an L, you stop the bleeding, but you just go kind of sideways. That’s what we’ve done. 

What that means, getting back to Dalio and Howard Marks, is that there’s really no precedent for what we’re experiencing right now. It would be very wary of that kind of forecasting and I’m in the forecasting business. You have to be really careful here because there’s no precedent for any of this. 

Now, the other important thing, in terms of what Marks and Dalio said, fail to separate the business cycle and a financial panic. You can have a business cycle recession, without a panic. We had that in 1989. You can have a panic without a business cycle recession. We had that in 1987, stock of October 1997, stock market fell 22% in one day. If that happened today, it would be the equivalent of 5000 data points. Not 500 but 5000 in one day, but there was no recession. 

Actually, there’s no better time to buy them the day after because the market came back slowly. So you can have business cycle recessions with no panic. You can have panics with no business cycle recession. But every now and then they come together. It’s again, I hate cliches, but it is the perfect storm of say two hurricanes converging. That’s what we had in 2008 -009. We had a recession, a severe one, but we also had a panic. 

So when Dalio says, “This is going to go on for a long time,” he might be right about that. Then we’re going to have a sharp break but it is going to build. I would say, you’re really confusing the business cycle and the panic. Panic could happen tomorrow, or any one of 100 reasons. I use complexity theory. I use behavioral economics, behavioral psychology. I use Bayesian statistics and Bayes theorem. 

What that tells you is that a panic can happen at any time, for reasons that cannot be predicted. You see them after the fact. But people ask me all the time, “Well, Jim, when’s the next time we’re going to be here? When should I sell my stocks?” As if you know, I’m going to call them up at three o’clock in the afternoon the day before and say, “Well sell them now because it’s going to happen tomorrow.” 

So look, I’m not going to know what happens. No one’s going to know what happens. That’s what a panic is, comes out of nowhere catches you by surprise. You get a predictable behavioral response, sell everything. 

Remember, I was in Japan in September of 2007 and the Japanese stock market was tanking. My Japanese friend said, “Jim, we don’t get it. We understand your American mortgage problem. Why are our stocks tanking?” 

I said, “Well, that’s because the hedge funds are getting margin calls on their mortgage positions. They want to sell the mortgages, they can’t. They’ve gone no bid. So they have to sell good stuff to get money to pay the margin and good stuff is Japanese stocks. But the reason they went out of business was because people say well that I know that guy’s good for the money. So I’ll call him. This is how contagion works.”

The contagion has come to the Japanese stock market, because people need money to meet margin calls on bad mortgages and that’s just how it spreads around the world. 

Now having said that you can’t predict it with high precision in terms of timing, and you won’t know what it is. That’s the other thing that people… See, well, I’ve got a whole long list of what causes the next panic, but I promise you it will be something that’s not on your list or my list or anybody’s list, because if it’s in our list, we’ve kind of thought about it. We’re doing something about it. So things you don’t perceive. 

I turn the question around, I say, “Don’t ask me when it’s going to happen or what’s going to cause it. I will promise you it will happen. My question is, are you ready? What are you waiting for?” 

In other words, if you agree it is going to happen and we won’t be able to see it very far in advance, why don’t you prepare for it right now? You just have to separate the business cycle and the panic. They’re two different things. 

Stig Brodersen  36:13  

I think this is a great opportunity to talk about your new book, “Aftermath,” when you’re talking about how the stock market has changed, even though your book is not out on the street yet, correct?

Jim Rickards  36:23  

That’s correct. I’m very excited about it. It’s coming out July 23, “Aftermath.” I have a whole chapter on passive versus active investing. Now Jack Bogle just died recently and he was the father of indexing and he said, “Look, you can’t beat the market. Just buy an index fund, pay lower fees, buy, hold, and sit back, you’ll get rich.”

Well, there’s a little something to that. The fees are lower. Buying and holding has been better. Most people panic. They buy high and sell low. That’s a good way to lose money. So there’s something to it but the premise is two things were wrong about it. 

Number one, the premise was showing you can beat the market. Most managers don’t, but some do. How they do it is interesting and I explore that, but more to the point. Passive investing and index investing are really a parasite on the body of capital committers. It’s just the people who actually make… 

They buy when everyone else wants to sell, they sell when everyone else wants to buy. They stand up against the market. They’re contrarians. They look for trend reversals. They commit capital and they win or lose. As you say, they can’t beat the market but they’re price makers. 

The passive investors are price takers. What happens when passive investing is 70% or 80% of the market and so on the way. All of a sudden, you don’t have the capital committers. Everybody’s a parasite. Nobody’s a healthy body, putting out the blood. 

Then you have a panic. As I said, it could happen anytime. All the passive guys, “Well, we got to sell because we’re indexers. We have to get out of this.”

It’s all robots. And when I say robots, I mean real robots. What I mean by that is an order matching system. So you want to buy something, I want to sell something. We want anonymity. We put our orders in, and the computer matches our orders, and we’re done. That’s been around since the 90s. That’s instant. That’s a lot of other systems. 

That’s not what I’m talking about. I’m talking about how the computers actually make the decision. The computer decides to buy or the computer decides to sell based on a high r-squared of some regression that between *inaudible* in Brussels and Ford Motor Company stock. 

James Simons’ great insight and Robert Mercer’s were the first thing you learn is statistics, your first week of class, they say, “Well, correlation does not mean causation.” They beat it into you, and you got to separate it. Correlations, r-squared is point nine, but stock causation.

What Simons and Mercer said was, who cares? We don’t care about causation. All we care about is correlation because if you can find it, you can trade it. It’s like umbrellas don’t cause rain. They’re highly correlated, like 100%. Umbrellas don’t cause rain. But they’re like, “Who cares? If I see umbrellas and I know it’s raining, buy the rain.”

That was a revolution in and of itself. Of course, they made 10s of billions. But that’s the world we’re living in. The robots are over 90% of the trading. They train them… I say train as if they’re organic but they are not. They use artificial intelligence, big data. They scan like every document the world for keywords. I can guarantee you the patient is programmed in every computer, and they look for that they spread statements. 

The problem is they’re all all the coding and all the algorithms on the word recognition software are done by the same 28-year-old engineers from Caltech or Bangalore, who know a lot more about coding than they do about markets. They all like to code the same way. All the robots move in the same direction. They feed on each other at microsecond speeds. 

At least so far we’ve been able to survive the flash crashes, but one of these days, it’s going to go down. It’s going to keep going down because all but one computer is going to erase the other to the bottom. 

Investors are not ready for that. So I go through two things: number one, what are the clues staring us in the face that we’re not paying enough attention to and we’re not putting enough weight on that are going to sink the market and cause a panic, but we could have stopped it, but we didn’t?

Preston Pysh  40:08  

Awesome. Well, when it comes out I’ll be sure to tweet about it and remind our audience because it is always a pleasure to sit down with one of your books and read through because you always have such insightful things to comment about and just really kind of spark a lot of thought. 

I just want to thank you personally for always making time to come on our show. I know Stig and I are just thrilled when we get a message back from Allie saying that you’re going to come on. So Jim, thank you so much for making time tonight to chat with us.

Jim Rickards  40:39  

Thanks for inviting me.

Stig Brodersen  40:40  

Alright guys, that was all that Preston and  I had for this week’s episode of The Investor’s Podcast. We will see each other again next week.

Extro  40:48  

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