This Is An Extinction-Level Event
James Rickards predicts the Fed will continue to raise rates and stall the economy.
Transcript (edited for readability
Albert: James, welcome back to The Power & Market Report. How are you
James: I’m fine, Albert. Thank you. It’s good to be with you.
Albert: First, before we start though, I want to let the viewers know that April 5 is the first anniversary of The New Case for Gold. So, congratulations on that.
Albert: And on April 7, you’re releasing the paperback edition of The Death of Money. So again, congratulations.
James: Thank you. And the paperback edition of The Death of Money as you know, Albert, New York Times Bestseller. It came out in 2014. A couple of things-you’re right, the paperback edition is coming out in a couple of days. It’s unusual. Usually a publisher would go to a paperback within about a year of the publication of the hard cover, but the hard cover, I’m happy to say, sold so well for so long that they delayed the paperback edition. But now the paperback edition is coming out. It has new material in it, so it’s not just a soft cover of the old book. It actually has some-a new preface I wrote that kind of goes over the material, shows why it has played out the way we expected and also adds entirely new material including new disclosures never before published on insider trading ahead of the 9/11 attacks. So, I’m very excited about this. It’s a very timely book. It’s still timely after a few years with some very new material included.
Albert: You know, I was going to joke at the beginning of the show that, you know, it’s been 3 months since we last talked and where is the new book? It turns out there actually is a new book.
Albert: I also want to tell the viewers that on April 4, you and I are going to be participating in a webcast with Rick Rule and Trey Reik and the topic is “Will Gold Trump Politics in 2017?” I can’t think of anyone else I’d rather talk about this with than the three of you. I’ll be moderating the discussion. If you want to register and you’re watching, go to SprottUSA.com and there’s a tile where you can register for that event. That’s April 4.
And finally, I’m also very happy to announce that James you’re coming back to our conference in Vancouver once again this year. You’ve been extremely popular the last 2 times you came to speak. And so that’s July 25th this year in Vancouver. It’s the Vancouver Natural Resource Symposium put on by Sprott. And if you want to go to that event, you can find out about it atNaturalResourceSymposium.com. The price is discounted now and it’s going to be going up quite significantly. Also, if you sign up now, you can get the MP3 files from last year’s event. You can hear James’ spectacular talk from last year. So, that is all the news. I’m looking very forward to that.
James, we have some things to talk about. Let’s start with the Fed. They seem to be following through on some of these rate hikes. Vice Chair Stanley Fischer says he sees two more hikes coming in 2017. Do we believe him? And should we care either way?
James: Yes and yes. We should believe him and we should care. You know, Albert, going back to last December, of course, December 2016, the Fed raised rates and then immediately after that, you know, based on my analysis, I’ll explain the model I use because it’s fairly straightforward. I said the Fed would raise rates again in March 15, 2017. I said that in December. I said it in January. I said it in February. What was amazing to me, we had this Fed fund futures contracts and you can look at the price that the Fed fund futures and do get the market probability. What probably of the market is assigning to certain-to another rate hike by the Fed.
And if you follow the wisdom of crowds and so forth, you will say, “Well, this is all the money in the world, all the interested parties in the world coming together in one very liquid marketplace setting a probability. And then in December, they put a 28% probability on the March rate hike-a 28% probability. Throughout January, it was 30%. February, it was 30%. The whole time, I was thinking 75% or 80%, you know, quite certain they would raise rates. You never want to say 100%. That’s silly but I was going to-80% converging on a 100%.
Then suddenly, in three trading days right around the end of February, early March to kind of February 27th, 28th, March 1st, March 2nd, the probability went from 30% to 80%. That was caught up to where I was all along. It was one of those hockey stick charts where it’s flat and it just goes vertical. And then, of course, by March 15th, all of us converged on 100%. It was very clear that the Fed was going to raise rates by that point. But I was amazed. It was very clear to me in December that they were going to do it. The market stated 30%. Why is that? Just because markets are collective wisdom and they’re liquid doesn’t mean they always get it right. Sometimes they have these catch-ups.
The reason is that the market, believe it or not, actually doesn’t understand why the Fed is raising rates. I realize that’s a major statement. Let me just take a minute to unpack that a little bit. Here’s my analysis. The economy is fundamentally weak. The Fed is raising rates into weakness. By the way, I expect they’ll raise again in June, so here we are in late March coming up in April. I’ll just say that as of now, my expectation is they’re going to raise again in June. This is what Vice Chairman Stanley Fischer suggested yesterday. But, they’re not raising them because the economy is strong. Actually, the economy is fairly weak. They’re raising it for a completely different reason. This rate hike cycle that the Fed is in is detached from the business cycle.
Normally, the way it works is that, the economy gets stronger, labor markets tighten, unemployment goes down, inflation picks up and the Fed is watching the whole time and they say, “You know what, we better raise rates.” Then they raise rates. Sure enough, the economy slows down, unemployment goes up, inflation comes down. We get close to a recession. Maybe we’re in a recession and the Fed is watching and the Fed says, “Oh, we better cut rates,” and so forth. So we had this nice kind of sinewave-the cycle. But what’s important about that is the Fed does not lead the economy. The Fed follows the economy. So as the economy is going up, the Fed is watching and then they tighten. And as the economy cools down, the Fed watches and then they ease.
So, the Fed follows the economy through the business cycle and that’s what the market is saying. But that is not what’s going on right now. What’s going on is the Fed is trying to raise rates even though the economy is weak because they’re trying to raise them to get them high enough so they can cut them in the next recession, which could be coming very soon. I mean we’re eight years into an expansion. This is extraordinary long. This is long by post-1980 standards, which is an era of long expansions. It’s double the average expansion since the end of WWII. This is an extremely long expansion. It’s been a weak one, one of the weakest expansions in the US history, but a very, very long one. So, no one should be surprised if we have a recession tomorrow. I’m not forecasting that. I’m just saying that we’re at a stage where that could easily happen. The Fed knows this.
Now, the data shows that you have to cut interest rates 3 or 4 full percentage points, 300 basis points and there’s a little more, to get the US out of a recession. How do you cut interest rates 3% when you’re only at ½ of 1%? The answer is you can’t. You’ve got to-and by the way, the evidence is that negative rates don’t work. Negative rates are not more of the same like more cutting when you go from 0 to -25 to -50. Technically, you’re cutting rates but that does not have the same effect as cutting positive nominal rates. So that doesn’t work.
So, the Fed is desperately trying to get the rates up so that when recession hits, they can cut them again to get us out of the recession. The problem is: Can you raise rates in a weak economy without causing the recession you’re trying to cure or getting rid of the cure? My view is they’re not going to be able to pull that off. Why is the Fed in this situation? Well, the reason is they missed an entire tightening cycle. The time to raise rates was 2010, 2011, 2012. In the early stages of the recovery, that’s when you raise interest rates. The Fed didn’t. They skipped the whole cycle because of Ben Bernanke’s crazy experiment with zero interest rate policy in QE1, QE2 and QE3. I think the viewers are very familiar with all that. We don’t have to revisit all that. We’ll look back and this will be viewed as a major failed monetary experiment where we’re all the guinea pigs.
But they skipped the cycle, so now they’re playing catch-up. So they’re raising rates at the worst possible time because they’re trying to catch up and get them high enough so they can cut them when the next recession comes and do that without causing a recession, which they probably will.
Now the market doesn’t see what I just explained. They do all these correlations and regressions. This is just typical Wall Street research. So they see a correlation between raising rates and a stronger economy. Well, that’s true. There is a correlation between raising rates and a stronger economy. Historically, it just doesn’t apply now because we’re guinea pigs in this experiment that I just described. So what’s going on now is completely different than what Wall Street understands. All this happy talk that we know, the Fed is raising rates so the economy must be strong. No, it’s completely backwards.
First of all, raising rates doesn’t make the economy strong. It’s the other way around. A strong economy causes the Fed to raise rates, but that doesn’t even apply now because as I said they’re playing catch-up. And this will persist. Now, the Fed will raise rates 4 times a year every other meeting for the next 3 years into 2019 until they get them up to 3.5% to 4% unless, unless-this is important-one of 3 things causes them to pause. There are 3 things that would cause the Fed not to raise rates. One is a major market meltdown. I mean 10% or more. In other words, there’s a full-blown correction. 5% won’t do it. So, if the Dow goes down 1000 points, the S&P goes down 100 points, that will not throw the Fed off this course. That will not throw them off their game. It’s got to be double that, you know, on its way to 15% in which case the Fed would pause.
The second one is if you see job creation fall below 75,000 a month, a very low threshold by the way. I mean recently monthly job creation on the most recent report was over 200,000. It was very strong, but even if you saw that 125,000 or 100,000, that’s not enough. It’s got to be 75,000 or less certainly if we lose jobs.
And the third thing is disinflation. The Fed has this target of 2%. They use a core PCE deflator. So year over year, PCE deflator core, they want that to be 2%. If you see that going backwards-down to, you know, 1.4, 1.2 or less, that will throw the Fed off the game. But those are the only 3 things. So, job creation dries up, disinflation or some kind of market panic either here or abroad. If you see those 3 things, the Fed will pause. If you don’t see them, they’re going to raise rates. So this is a very easy forecast to make. It wouldn’t surprise me after those factors for them to raise 3 more times, you know, March, September, December. Now I don’t think they actually will and the reason is that-the first reason I mentioned which is in the course of raising rates, they’re going to stall the economy and then you’ll see the disinflation or the market crash that will cause them to pause, but we’re not there yet. This won’t really sink in until the summer.
Albert: You just blew through my next 3 or 4 questions so you’re a mind reader as well, James. But of the 3 things you mentioned, to me it seems that the severe market correction is the scariest of them and they obviously-the disinflation is also scary because they could cause a meltdown in asset prices. I don’t see them getting through 2018 without causing something like this, and then I understand what you’re saying about the 10% threshold. But I think if the market goes down 5% and the Fed doesn’t flinch, it’s going down 10% or maybe even more. What are your thoughts on that?
James: Well, if it does go down 10%, they’ll pause. But if it goes down 5%, they won’t. And by the way, I talked to Ben Bernanke about this when I called up with him in Korea. He said the Fed doesn’t care unless the market goes down 15%. 15%, which would be 3,000 Dow points, it actually gets scary-looking.
Yeah, those kinds of corrections would cause the Fed to pause. They definitely would not raise rates in that situation. But at 5%, they literally don’t care. Now, your point, Albert-well, gee, if it’s 5% or 6% or 7%, aren’t you on your way to 10%? You might be. It depends on the momentum. Right now, it’s kind of like stalling, a little slow grind down. This isn’t a crash. This is just grinding down. That’s not going to upset the Fed that much. They would say it’s not their job to prop up stock prices even though they have, in fact, done that because of this so-called wealth effect.
But if it goes down precipitously, like 1 or 2 percentage points a day, day after day, so it’s-you know, 2 weeks go by and we’re down 10%. -that would cause the Fed to pause. And it’s obviously very dangerous because of the instability of the system as a whole. Now, on that point, I’ll be brief. I separate the business cycle, the kind of crash you might get in the business cycle or recession from a systemic crisis. Both of those things can cause the market to go down, but it goes down for different reasons.
In a normal business cycle, stock market is supposed to go down because earnings are going to dry up and multiples are going to contract and people are going to sell stocks and it might get a little bit disorderly and you might see a 10% correction. That can be associated with a normal business cycle. But you can also see the market crash for systemic risk reasons. This would be some kind of shock, the kind of thing we saw in 1998 with Russia, the kind of thing we saw in 2008 with, you know, Bear Stearns, Fannie Mae, Freddie Mac, Lehman Brothers, all in pretty close sequence.
The 2 things can go together. You can have a business cycle correction without a panic. You can have a panic without a business cycle correction. We had that in October 1987-October 19, 1987. The stock market dropped 22% in 1 day. 1 day. That would be the equivalent of 4,000 Dow points or 450 S&P points in one day. But, there was no recession in 1987. It was a shock. Some people went out of business but the market recovered. So, panics and business cycles are separate phenomena but they can go together which they did in 2008 and also in 1929. That’s kind of the worst of all possible outcomes.
Albert: I agree. James, I was going to joke and ask you what you were doing in North Korea, but I think that would get me in trouble with people who don’t have a sense of humor. I’m not calling Bernanke a communist. It’s a joke. But-
James: We were close to-we were in South Korea, but we were close to North Korea, not far from the border.
Albert: OK. I think you’re right. The fact that if the panic and the business cycle, the bust, coincide, you could have something very violent and I think that’s what we may be looking at this time simply because the panic will come from the fact that we’ve ignored the business cycle for so long. Like you said, we skipped an entire cycle by just acting as if it didn’t exist, keeping rates pegged to zero. So, what probability would you put on that? The big business cycle correlated with or corresponding with just a massive panic like we saw in the ’80s.
James: I agree with that and I think it’ll actually be a lot worse than certainly what we saw in 2008 like it should be. To me, this is more of an extinction level event as these things go, as economic crises go. But the reason I think the business cycle will fall out of bed along with a systemic risk is because the Fed has smothered the business cycle with zero interest rate policy, money printing, expanding the balance sheet, forward guidance-all these manipulations.
We didn’t have a real low in 2008. What I mean by that is you hear a lot about the V shape recovery, so the economy goes down very sharply and then it goes up very sharply. That’s a normal kind of phenomena in a business cycle. It’s what happened in 1981. It’s what happened in 1974. It didn’t happen this time. What happened is we started to go down sharply, but the process was truncated because of Fed intervention, not just money printing in QE1 and zero interest rates but tens of trillions of dollars of swaps with the European Central Bank when Europe was desperate for dollars. The European Central Bank can’t print dollars. They can only print euros, so we printed up a bunch of dollars. They printed up a bunch of euros. We swapped them, again, to the tune of tens of trillions of dollars in euros swapped. We didn’t know that at the time. It was suspected, but it was years later because of Dodd-Frank and some congressional hearings that that information came out.
But what we did know at the time is they guaranteed every bank deposit in America. They guaranteed every money market fund in America. They didn’t have to. I mean we had FDIC insurance up to a limit. There wasn’t a guarantee on money market funds but the Fed went in and guaranteed them. So, they took these extraordinary actions. They did truncate the collapse, but you never got it out of the system. We never had the write-offs, the bad debts, the foreclosures, the things that should have happened to get the system to a point where it was able to grow much more rapidly above trend on a sustainable basis and get back to trend.
What we’ve had instead is below trend growth for eight years. The US is Japan. I said this in my first book, Currency Wars, in 2011. I actually said it before that that. Bernanke spent the early part of 2000s just excoriating Japan. He says, “Japan, you don’t know how to run monetary policy. You don’t know how to get out of a recession.” People talked about the lost decade then it was the lost two decades because-I mean it started in 1990. So by 2010, you had two lost decades. Now we’re more than halfway through a third lost decade. It’s been 27 years of on and off recession, depression, deflation, disinflation in Japan, nothing like trend growth.
And Bernanke criticized them and yet he made every mistake the Japanese made. We are Japan. The US-our best case is 2% as far as the eye can see, which will cause the country to go bankrupt because our debt is growing at 3%, 3.5% a year for now and it’s going to grow at 4% or more beginning in a couple of years. Our debt-to-GDP ratio is at an all-time high when you count contingent liabilities, but even just the actual debt is 105%, which is approaching the levels not seen since the end of World War II. We’re on the path to Greece.
You know, when you grow your economy at 2% and you grow your debt at 3% and 4%, you’re going broke. You may be going broke slowly but that’s a recipe for eventual insolvency and the only way out of that is actual default or a very powerful inflation, which they haven’t been able to get.
So you have all these disaster scenarios in the making, but meanwhile, as I say, it just-it looks like that the business cycle will wind down because it’s been going on so long combined with the systemic risk we’re talking about but on a bigger scale because the banks are bigger, the balance sheets are bigger, the derivatives books are bigger and one of the key lessons or key teachings of complexity theory which is the best way to understand the economy is that risk is an exponential function of scale. What that means is that when you double or triple the system, you don’t double or triple the risk. You increase it by a factor of 10 or more. And so we have increased the system and we’ve increased the risk even more which is why I say the next crisis is an extinction level event.
Albert: Let’s talk about the Federal Reserve and the governors, James. In a previous conversation, you talked to me and related a story that a speech writer had presented-I think it was Bernanke at one point-2 speeches-one dovish, one hawkish and Bernanke didn’t know which was which. These guys are all coming out this week on the calendar speaking-some of them more than once. What are they trying to achieve by talking to the markets directly?
James: Well, a couple of things. That’s true the story you’re referring to is in my last book, The Road to Ruin. This anecdote is in Chapter 6. It wasn’t exactly a speechwriter. It was, basically, the guy who’s in charge of communications policy. But when I say communications policy, I’m not talking about speeches in public relations so much as the actual writing of these releases that come out at the end of the FOMC meeting. But it would also include some of the content of some of the speeches. This person had the office across the hall at the Federal Reserve board in Washington from Ben Bernanke and later Janet Yellen and worked with both chairs-was very close to both of them.
And the story was they were getting ready to issue a release and had two versions, you know, one was slightly more hawkish than the other. But the point is they do this wordsmithing and Bernanke looked at the two drafts and he said, “Which one is the bad one?” which shows how arbitrary the words are. And what they really did was they called up the Wall Street journal and leaked their message and then the Wall Street Journal regurgitates it and everyone goes, “Oh, now we know what it means.” But it’s really just wordsmithing and leaks and that’s how they operate. That’s how they operate forward guidance.
But as far as the speech is concerned, one thing I can say to a lot of people all the time is there are seven members of the Board of Governors or I should say there are 7 seats. Right now, two of them are vacant. There’ll be one more vacancy next month. So there are really only five members of Board of Governors today, soon to be four. There are twelve regional reserve bank presidents. So, right now, you have a total of seventeen Fed heads if you want to think of it that way-the governors and regional reserve bank presidents. There are only 4 you need to listen to. You can completely disregard the rest. They’re nice people. They’re smart people. If you’re a real geek and you want to read the speeches, that’s fine but it has no impact on policy is what I’m saying.
They’re only four you have to pay attention to-Janet Yellen, Stan Fischer, William Dudley, president of the Federal Reserve Bank in New York and he’s the only reserve bank president who counts, and I would say to a lesser extent but still important, Lael Brainard. Lael is a member of the Board of Governors. She’s the expert on international contagion, international spillover. She was the one who in late February or mid-February 2016 basically persuaded the Fed to switch from tightening to ease, go dovish, in other words. She was also very influential in September of 2015 to get the Fed to push back the lift-off. Remember the famous lift-off when they were going to raise rates? It was all teed up for September 2015, but you had that meltdown in the Chinese stock market and then the US stock market in August 2015. And she was influential in saying “Don’t raise rates now,” and they did push it back to December of 2015 for the first rate hike. That was the lift-off.
So I pay attention to Yellen, Fischer, Dudley and Brainard. Everybody else you can completely ignore. Now having said that, this is all about to change radically because of President Trump. Donald Trump owns the Fed right now. He owns the Fed, and let me explain why that’s true. Because the two vacancies I mentioned, well, a third governor, Dan Tarullo, just announced his resignation effective in April. So, count that as a third seat. So they’ll have three vacancies soon. You have J. Powell who’s on the board today. He’s a republican. He’s the only republican. He hasn’t had anyone in his sandbox for a long time but he’ll soon have three Trump appointees. So you’re going to have four kinds of republican appointees probably in a matter of weeks.
Beyond that, Janet Yellen’s term ends on January 31, 2018. But that requires Senate confirmation, so they’re going to have to name her replacement before then so the Senate can schedule confirmation hearings. So Trump will probably make that appointment maybe as early as November or December, which is not that far away. That’s just another six months away-so there’s five. And then, Stan Fischer’s term ends in June 2018. Same thing-they’re going to have to announce that probably by April or May.
So within a year, just over a year from where we are now, Trump is going to have five new appointments and one Republican on the board. He’s going to control six of the seven members of the Board of Governors. The only Democrat will be Lael Brainard. She might resign just because she won’t have any friends. She’ll be like J. Powell today. She won’t have anyone to talk to. No president has had this many appointments at one time since Woodrow Wilson in 1913. That was only because all the seats were vacant other than there were two statutory seats at the time-the Treasury and the Comptroller of the Currency. But other than that, Wilson got to fill all those seats in 1914 because they were all vacant.
So Trump owns the Fed for the reason I just described. So that’s easy. Now the question is what does Trump want because Trump is going to get whatever he wants through the appointments process. The question is what does he want? He’s really flipped around on, you know-all during the campaign, he complained that China was cheapening its currency and then more recently complained that Germany was cheapening its currency. I mean Germany doesn’t have a currency. They have the euro, but that’s not run out of Germany. It’s run by the European Central Bank. Same thing with Japan, he’s pointing a lot of fingers but he hasn’t actually done anything about that. He said he would name China currency manipulator has not done that. He’s done a lot of what he said, but that’s not one of them.
So you think that Trump is a weak dollar guy based on that and yet you look at the people around him-David Malpass, Steve Moore, Larry Kudlow, Art Laffer, Judy Shelton, others. These are all strong dollar; sound money people and some of them are explicitly pro-gold. So I’m not saying Trump is going to go to a gold standard anytime soon. I’m just saying that I expect Trump to appoint hard money people. I think we’re going to see a big bang kind of an announcement where he announces three seats all at once including a vice chairman for regulatory matters and I think you’ll see that they’re hard money people. And again, I don’t know this for a fact, but there’s very good reasonably based on some conversations going on behind the scenes involving the White House that they want to put Kevin Warsh on the board and that he would actually be the next chairman of the Fed. He would replace Janet Yellen.
And what’s interesting about that, Kevin Warsh was already on the Fed. He was a governor, not the chairman, back in 2010 and then he resigned. Although these are fourteen-year terms, no one says you’re going to have it for fourteen years. Some-they leave at some point. So, Kevin Warsh has no reason to go back on the board unless he’s going to be chairman because he was already on the board. So, if you see Kevin Warsh go on the board, that’s a signal that he is going to be the next chairman because, otherwise, he wouldn’t take the job. So you could make Janet Yellen a lame duck by next month. Can you imagine being chairman of a board and there’s the next chairman sitting right next to you and everyone in the world knows it? It’s kind of embarrassing but as they say it’s the way to pull the rug off from under Janet Yellen.
So, I described why the Fed is on a tightening path having to do catch-up, trying to raise rates before the next recession. But I don’t see that changing. If anything the people I’m talking about, the Judy Sheltons and Kevin Warshes of the world, you know, let’s see who they actually are. But if they’re hard money people, if they’re Taylor Rule people-I mean the Taylor Rule would say that rates should be 2.5% today. So, I expect this hard money path to continue. What that means is they’re going to slow down the US economy because the economy is already weak and then we could be in a recession by the summer. So it’s, you know, kind of fasten your seatbelts in terms of what that means to the stock market.
Albert: Kevin Warsh, just like Richard Fisher, has been quite outspoken since he left. I think he would be an interesting confirmation, but you just turned everything upside down on me. So I was thinking that with Trump in and controlling five out of seven, we would expect a weak dollar. Also, I would have guessed that there would be QE4 eventually and it would go into infrastructure and building because he’s a builder, not a banker. We’re running out of time but just your quick comments of that. You’re thinking strong dollar not weak dollar with Trump?
James: Well, for the time being, yeah because Trump wants to do something about the trade deficit. That’s for sure. But they are not going to do it through the currency. They’re going to do it through trade policy, through tariffs. So, the attack on China is not going to run through the Federal Reserve Board in a weak dollar. It’s going to run through Wilbur Ross, Peter Navarro, Dan DiMicco, Robert Lighthizer who’s designated, you know, as his trade representative. That’s where they’re going to get China with tariffs and other non-tariff barriers more so than the currency wars.
Albert: OK, very good. James, I’ve kept you over, so thank you very much. I just want to remind everyone about the April 4, webcast, “Will Gold Trump Politics in 2017?” Check out that. Join me, James Rickards, Rick Rule and Trey Reik. Go to SprottUSA.com for details. April 7 is the release of the paperback edition of The Death of Money with a brand-new preface-and then later on, the July 25, Vancouver Natural Resource Symposium. You can check out that at NaturalResourceSymposium.com. Go now, get a discount. Also get the MP3 files with James’ presentation from last year. James, it’s always a pleasure to speak with you. Thank you very much and I look forward to doing it again.
James: Thanks, Albert. And just, The Death of Money paperback, that’s available for pre-sell on Amazon right now. So I hope the viewers you have a look and as I said there’s interesting new material on the preface.
Albert: Don’t wait. Get it now. Thank you very much, James. Take care.
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