Transcript
Hugh Hendry joins the Gold Exchange to talk about the underlying reasons for the coming banking crisis, the failure of the Yuan and the BRICS countries, and how the Fed is crucifying the common man.
Follow Hugh Hendry on Twitter @hendry_hugh and subscribe to his Patreon
Connect with Keith Weiner and Monetary Metals on Twitter: @RealKeithWeiner @Monetary_Metals
Additional Resources
The Case for Gold Yield in Investment Portfolios
Podcast Chapters
01:18 Banking Industry
03:36 Stateful
05:13 Fed Tightening
07:13 WMD’s
08:22 Duration Mismatch
11:55 Riskless Realized
14:51 Banning Short Selling
18:32 Yuan vs Dollar
22:06 Dollar Derivatives
26:00 Rupee vs Ruble
27:48 Lending to Dictators
28:35 Hendry’s Law
32:29 US Transparency
34:52 Productivity
39:32 Marginal Productivity of Debt
42:42 The Failure of Econometrics
48:20 Yield Curve and Bagehot
50:52 Hugh’s Question
51:29 Find Hugh
52:35 Hugh’s Conference
53:46 Monetary Metals
Transcript:
BVN:
Welcome back to the Gold Exchange podcast. My name is Benjamin Vern Nadelstein. I’m joined, as always, by founder and CEO of Monetary Metals, Keith Wiener. We are joined by a very special guest today, Hugh Hendry. Hugh is the acid capitalist, the macro artist, the market surfer, the wizard of finance, and he’s joining us today on the Gold Exchange podcast. Hugh, how are you doing?
Hugh Hendry:
Hi, guys. I’m overwhelmed by that description. I’m good, thank you. Very good.
BVN:
Hugh, I’ve listened to a bunch of your interviews now and you said there are about five people who understand the complexity of money. Now, I don’t want you to name names, even though I’ve got this government suit on, but I want to posit that Keith might be the sixth person who understands money. We’re going to find out today. So, Hugh, let’s start with you. The banking industry has had a lot of turmoil in the past couple of months, but I’ve had a lot of people tell me, Ben, everything is totally fine. The banking system is back to normal. Sure, SVB went down. Sure, a couple of these crypto banks went down. But if your dollars are FDIC insured, everything is fine. Do you agree with that statement that everything is fine?
Hugh Hendry:
I mean, it’s fine if you have no conscious thinking mind. Whatever. It’s just preposterous. Okay, how do I sum in the energy? I’ve done my Elon pause. We’ve had four historically very significant financial institutions significant with regard to the size of their asset base, and they are no longer with us. And that has occurred across jurisdictions. We had a major Swiss bank deemed to be systemic or significantly important to the overall economy, is gone. And we had, what, three US banks. And that is before we get a recession. Typically, banks are nailed by the unexpected arrival of an economic correction, which is a shock that requires higher and higher credit charges and and also leads to a crisis of confidence in their collateral and so other banks withdraw. It is with some concern that we’ve already witnessed four banks disappear. However, it’s within the historical precedent. We’ve heard all of these things before. We had Bear Sterns vaporize in February of 2008. We were assured it was a one-off.
If you’re of that type, there’s nothing I can say that will change your mind.
BVN:
Keith I want to jump to you real quick. A concept you brought up in your theory of interest and prices is stateful, which is that these banks, they can’t just turn around one day and offer you what the Fed is offering at, let’s say, 5 %. They’ve got a whole portfolio of assets that they have to slowly, over time, de leverage. Can you talk about that a little bit?
Keith Weiner:
Yeah. So we’ve had a falling interest rate for four decades and now suddenly rising. Everybody expects the bank to offer all depositors, not just the new depositors at the margin, the new higher rate. If T bills are paying 5 % ish, then why can’t my bank offer me four and a half? Well, they have this portfolio acquired over many, many years, if not decades. That’s probably paying them under 2 %, and that doesn’t go away. The Fed can change its policy inputs, as they would call it, but doesn’t change the state of the bank’s, not just balance sheet, but its average portfolio yield. And it’s not an easy problem to work your way out of. One by one, one of those assets roll off as they hit maturities and then the bank can buy assets at higher yields bit by bit. So that’s I think one of the contributors pronged to the coming crisis is there’s a very strong incentive for people to pull the deposits out of the banks, namely in this particular case, namely higher yields to be had in something else. And it’s all going to feed on itself.
BVN:
Hugh, I want to jump to you. I am holding a weapon of mass destruction right here.
Keith Weiner:
It’s called the iPhone.
Hugh Hendry:
Me too.
BVN:
So can you explain to people what it means when you say that the iPhone is a weapon of mass destruction when it comes to banking?
Hugh Hendry:
Well, just to pick up on that very valid observation. This Fed tightening cycle is different from all its predecessors. It’s different in terms of the rapidity and magnitude of the hike. The Fed has never done this before and for good reason. First of all, it is the regulator of the banking system and therefore it is beholden upon it to be wise to the notion that the repricing of the asset book of a bank, like you said, takes 18 months. And so the Fed typically is very cautious and very transparent. It’s going to raise rates. It’s notified the banks in advance. And it typically raises 25 basis points when the economy began to take on momentum after the Nasdaq collapse at the end of the previous century, it was a very long drawn out sequence of 25 basis point increases which enabled the banks to reprice. That has not been the case. And that is crushing the net interest margin of the banks. But more significantly, it called into question the conceit and the arrogance of what was a well formed argument before we had this black Swan, a black Swan being the recording of something which has never happened before.
Which was the repetitive the Fed’s movement. So the conceit was that there were these held-to-maturity treasury portfolios and you did not have to mark them to market. And we were working to your point about these weapons of mass destruction. Before online banking came around, a bank run would maybe be 5 % of the deposits being pulled in the first day. You have to go through your passport. You’ve got to be in a queue. They purposefully go slower. With SVB, I think before they closed it, we were up to about 75 % of the deposits having been pulled. So this is the point. Banking, the banking model Humpty Dumpty is broken and Humpty Dumpty will not be put back together again because you no longer have the presumption of inert deposits. And so as a funding mechanism for these long-dated risk assets, that model needs a profound reworking. And that’s where we are today. We don’t know the new model, model 2.0 for the banking industry. And in the field of time, however, we will get a revelation.
BVN:
Keith, I want to send it your way. The banks were engaging in duration mismatch. They had short-term deposits and those deposits can go faster than ever with mobile banking. Do you think that maybe banks will no longer engage in duration mismatch? They’ve learned their lesson?
Keith Weiner:
If I was a betting man, I would bet that the regulators will come up with some fix, fix doing the wrong thing in order to enable something like that. I mean, what the bank should be doing, and I’ve written about this for many years, is match the duration of the deposit to the asset. So if you want to buy a 10 year bond, sell 10 year CB. But we’ve spiraled down in our monetary system where there’s obviously no demand for 10 year CDs. So the banks just figure, right, let’s get away with funding it with demand deposits and all of their formulas and rules and everything’s fine. You add to that, I think you said Hubris Q of, oh, we’ll just write it down as marked and mature, it holds a maturity, which, by the way, was a fix coming out of the last crisis. A lot of folks felt that marked to market exacerbate, if not cause the crisis, at least exacerbate it. Let’s give the banks the ability to hold to maturity. Well, it should be an axiom that even if you write something that’s… You can write something that’s false in your books and get away with it for a while, but eventually there’s a reckoning and you can declare your intentions to the stars.
We’re going to hold this forever, right? But circumstances may force you otherwise. To me, I look at online banking not as a weapon of mass destruction, but rather the removal of friction. Previously, if I wanted to move my deposit from one bank to another, there’s certain amount of friction. As you said, and I remember those days you had to get in your car and actually go to the bank. And in those days, banker’s hours were not normal nine to five. You had to show up before 3 PM, I think it was in those days. And it was a pain. And unless you really thought losses were imminent, people didn’t do it. If they thought losses were imminent, then there’d be a line around the block. But otherwise, it’s much slower. There’s a lot of friction. Now we’re taking the friction out and we find out that speed up of friction, the herd will move away from whatever bank is rumored to be the next unsound one, and they’re all unsound. And the other observation I was going to make, the problem with Silicon Valley Bank wasn’t that the asset was bad. It was simply the market price, the volatility of the price.
There wasn’t actually a credit impairment. There were treasury bonds. Wait until the recession when there’s actual impairment. I’m reading now there’s 20 hotels. One hotel in San Francisco just handed the keys back to the bank. There’s 20 more queued up, ready to go when their maturities hit. None of them can make any money in the present environment. What does that do? I don’t know which banks are the mortgage holders on those hotels, but what does that do? And is there another bank run? And this thing just feeds on itself? So what are they going to do? Probably not end duration mismatch, they’ll find some other fix.
BVN:
Hugh, I want to send it your way because you’ve made this point. The people who are running SVB, regardless of their personal risk management strategy, it had nothing to do with the fact that there were just morons who were working over at SVB, they were asleep at the wheel. It had nothing to do with that. Keith, you mentioned that all the time. Hugh, it sounds like people are blaming the specific bank, SVB, for what happened. It seems like a more broad or systemic problem. Can you comment on that?
Hugh Hendry:
Yeah, I mean, it’s a convenient truth to write them off as being an erroneous example of a badly mismanaged bank. They were a successful bank and they suffered owing to their success. They had attracted, I think their deposit, I guess, the monetary creation via COVID and with the bubble in private equity, you saw their deposits, which are their liabilities, shroom from what, 17 billion to 180 billion? And they took the fateful decision to invest that in long-duration government bonds. Assured, as Keith said, by the previous government fix that they wouldn’t have to mark these securities. So they were credit riskless and market price riskless. But it was none of us realized just how important online banking could be in the withdrawal of money. So this is a threat that is shared by all. But I think what has gone without great comment is that it was actually the JP Morgan’s of this world which led to the very rapid demise of the bank because every day, regional banks present a portfolio of their loans as collateral in going into the repo market where their counterparties would be the large money center banks, Citigroup and JP Morgan, et al.
And they offer that typically without a haircut. So they present, let’s say, a billion dollars have a diversified portfolio of their loans, and in return, they will secure financing, which allows them to keep their business afloat. The money center banks began to, if not refuse, but insist on haircuts which were of such a magnitude that effectively the other banks closed the funding of the institutions that failed. The same thing happened in 2008. Jp Morgan was the platform for the holding of the collateralised debt obligations, supporting the mortgage market. Jp Morgan wrote to all clients and said, We can no longer accept this and we’re closing you out. Every recession, every bank crisis, begins with a crisis of confidence in collateral and with the confidence of counter parties.
BVN:
I want to talk about JP Morgan for a second. There’s been some talk in the air about banning short selling. When banks get in trouble, the real issue here, you don’t understand, is that people are shorting these banks. Shorting is the problem. Shorting, as long as we ban that, the banking system will be fine. That crisis of confidence will no longer happen if shorts are not allowed to do what they want. Now, Keith, I see you chuckling. Let’s start with you. Should we ban short selling, Keith?
Keith Weiner:
To me, it’s just like, should we insert friction into the system? If a bank is fundamentally insolvent and running into inability to or let’s just say eloquent, forget insolvent for a minute. It’s fundamentally unable to finance its portfolio, which is going to cause the default. And then you say, okay, you’re not going to short the shares. That’s just inserting friction to make it harder for the share price to go down. Down it must go eventually, but you’re just making it harder for that to happen and then assuring the longer you hold that force back, finally, when it bursts free, the more it will overshoot. And so mechanically, when something is in freefall in the market, the short seller provides the bid. Short seller is saying, well, if it hits 40, I’ll buy this much back. And if it hits 35, I’ll buy this much back. And if there’s no short sellers in the market, there’s literally no bid. Everyone’s saying sell, sell, sell. The thing can hit zero. Everyone’s selling it to market and there’s no bid. So you’re just adding friction into it. And then eventually the damn bus loose and then you got a worse drop than before.
So I think those sorts of proposals, I think it was Jamie Diamond who said that you shouldn’t be allowed a shorter bank share is at best foolishly misguided.
BVN:
I think Ayn Rand is shaking her finger wagging it as saying, Reality, in her Russian accent, reality will come to… What do you think? Does JP Morgan have a point we should be banning the short selling?
Hugh Hendry:
Short selling is essentially muting the truth tell us. And to Keith’s point, it’s inherently unstable to the market process because it actually withdraws liquidity under stressful events. You remove a community of a constituency of the market that actually wants to buy on down days, and therefore you accentuate the downturn. But you don’t have to take Keith and my view on this. We have precedent. It has been done before. Everything that we’re saying has been proven valid. I think it was September of 2008, and the US government and other entities overseas banned the short sale of financial assets. They caused a terrific rally, which was then unraveled by the reality, by the truth. And the truth was profoundly damaging because we had removed that constituency. So again, it’s been done. But can folly strike twice? Sure. Short selling is not a wouldn’t really something I would recommend. When you think of David Einhorn, not to pick on David, but he was short, Lehman Brothers, a clarion forceful observation. He ended that year down because you had to close that position. What’s happening is very much macro, and there are many other ways to skin this cat without taking on the risk of an irrational policy response from the US government.
BVN:
All right, let’s jump to macros, Monty Python might say, for something completely different. Hugh, I have heard you say that the bricks countries are not going to take on the US dollar hegemony. You just don’t understand. And Hugh, I’ve heard you respond with a quote from Aerosmith saying, Dream on. There is no shot that these bricks currencies are ever going to replace the dollar. So Hugh, let’s start with you. Is there any shot that one of these other countries, let’s say China, they’re a big GDP, why don’t they replace the dollar?
Hugh Hendry:
Well, first and foremost, the bricks are China. Everything else is insignificant. Even India, I think is only… Is India the size of the GDP of Russia? It’s roughly two or three % of global GDP. So is China. China is the same size as the continent of Europe is approaching 18 trillion dollars. And for sure, the Chinese one could be a valid competitor to the dollar. But under the following circumstances, it runs an opened capital account, which is to say that as a forerunner, you’re allowed to invest in its property market, its treasury market, you’re allowed to open deposits. It would also require a rule of contract law which would be predictable and would be barred to be transparent and to be equitable. And in opening the capital account and being subject to reserve, if you will, most favored nation status, it is likely that China would have to accept that its currency in due time. Due time, why am I saying due time? If you were to open the capital account, if you were to allow Chinese citizens, again, to actually buy overseas assets, there would be a massive exit from China. Why? Because it has a profoundly overbought property market and they have a 60 trillion dollar property market.
I think US equivalent would be 35 trillion and US economy is substantially larger. So that’s 60 trillion dollars if you could actually invest it overseas. Effectively, you could own all of the property in the rest of the world. So under the conditions that Chinese citizens are free to buy and to move their foreign exchange as they wish. And that overseas suppliers to China receiving payment. I call it red cabbage, the Chinese currency. If I’m in Brazil, Brazil presently is doing a lot of bilateral trade with China. Why? Because it sells soy beans and other agricultural products, and of course, it has a very rich raw material base. There is no issue with regard to settlement. Many, many countries are free and indeed are choosing to accept the red cabbage and settlement for their goods and services. It’s what comes next. If you’re sitting in Sa n Paulo with red cabbage, you can’t go to Starbucks and buy a latte. And like I said, you can’t actually buy any financial asset in China. So it’s at the margin, your red cabbage is sold for dollars and you take the sanctuary of a market which has contract law and deep liquid markets where foreigners are welcome.
BVN:
Keith, I want to send it your way. You have claimed that all the other paper currencies are derivatives of the US dollar, and you think that no other currency could replace the dollar? There is something that could. It starts with a G and it ends with a D, has an OL in the middle. But can you maybe explain why no other paper currency can overtake the dollar, for example, that you want?
Keith Weiner:
Yeah, my comment about the other currency has been dollar derivatives is that all the central banks have huge amounts of dollars as the reserve asset. So if you’re a central bank, essentially you have dollars as the asset and you issue your local currency as the liability to fund that asset. Now you can shuffle that around and say, okay, instead of holding dollars directly, we’ll hold another currency. But that other currency is also a dollar derivative. So the US runs open capital account as you said, and generally huge trade deficits. Triffin’s dilemma, right? We’re supplying the rest of the world with the reserve currency, which means we have to export currency or at least financial assets of some sort. And all the currencies have ended up as a result of a lot of historical legacy, Bratton Woods, etc. Holding dollars is the ultimate backing of everything. And we had another guest on our show, Jeff Snyder, who said you can basically say it’s a dollar world and the other currencies are secondary scripts like coal mining company talent script. It really is a dollar world. I was going to say to confirm in a different way what you said.
I visited China once right before COVID, but it was so close that when I was traveling in Australia, and they started to say that anybody who’d been in China within the last 90 days is prohibited. I actually had to look at the stamp on my passport to verify that my trip to China was more than 90 days outside that window. And it was, but only just. And I met with some wealth advisors there to talk about our Gold Guild program. I thought the Chinese might like the idea of a non dollar asset, but outside China. The wealth advisors there have the same job as they do in the rest of the world, which is to help people understand risk and time transference and in what stage of the game are you at and portfolio allocation and all that. But in addition, I would say their overarching mandate is to help people navigate the loopholes in the capital controls and sneak their money out either by breaking the law or by skirting it narrowly. And that’s the thing that everybody with any degree of wealth in China is attempting to do is to get their wealth out of Yu an and out of the Chinese government’s purvey because they don’t like, although the term red cabbage, they don’t like the red cabbage, and they don’t like that it’s under the control of the Chinese government.
And if they say one wrong word, then it’s subject to confiscation. They’d like to have wealth in a different form and outside that control. And so if you open the capital account, I can only imagine just how much selling there’d be by the Chinese. And what would that do to the price of the yu an? Hard to predict, but surely at least 50 % to 75 % drop, maybe a lot more than that. And that wouldn’t be an auspicious start of something that’s going to be the alleged future world preserved currency. The other thing, I just want to conclude this comment on an ironic note. So there’s much ballyhooed bilateral trade between Russia and India. And was it India or was it Russia? I think it was India said, well, we don’t want to hold these useless rubies.
Hugh Hendry:
No, it was the other way, Keith.
Keith Weiner:
Russia?
Hugh Hendry:
Russia had accumulated 50 yards of a dollar equivalent rupees because, of course, the Indians have been accepting Russian embargoed oil. And then you can continue.
Keith Weiner:
Right. And the Russians are like, well, these rubies are useless. We don’t want to hold them. And it’s like, well, yeah, definitely. So I don’t know if you’ve seen the ongoing banter. A few of us, including Brent Johnston, have talked about the cab driver test. Can you give dollar bills to a random cab driver in some places in the world? And I had an experience not too long ago in Switzerland, where much to my surprise, the cab didn’t accept credit cards. And I don’t bother going and exchanging. But I had a couple of $20 bills I just always have in case of emergency. And he was happy to take the dollar at par, ironically, even though the Swiss franc was one over a dollars six at the time or something. He was more than happy with a big smile. Oh, yeah, absolutely. A 20 fronk fair was $20. That’s the world. That would not happen in rupees. That would not happen in Taiwan. That would not happen in rubles, Brazilian real, you name it.
Hugh Hendry:
I tell you, Keith, but you must have been going 200 yards in that taxi for it cost you 20 bucks in Switzerland.
Keith Weiner:
It wasn’t very far. You’re correct. It was not very far trip.
BVN:
If you had a poll on your Twitter and we had Brent Johnson comment on it, he said, I wish I’d ran this poll. The poll was, all right, which of these countries and leaders would you like to lend your money to? You can have Xi in China, you can have Modi in India, you can have Lula in Brazil, you can have Putin in Russia. Who do you really want to lend all your money to? And obviously, the answer is funny because it’s none of these countries. I don’t want to have any of these dictators having my currency of any sort, let alone gold. And it just highlights this fact that there’s a lot of talk, Oh, the bricks, gold bag currency. We’ve had this field guide out, how not to think about gold. We debunk all this crazy talk. But at the end of the day, what rule of law, what country, what capital account is going to have the best liquid markets, best rule of law? And the answer is the United States. Hugh, I want to go maybe to the second competitor, which might be the Euro. And I want to coin a phrase here that I want you to steal, which is called Hendry’s Law.
Bad policy drives out good policy, which is obviously a joke off of the Gresham’s law, which is that bad money drives out good money. And you made this point about the European currency and the Euro, which is that Europe is just doing every bad policy mistake you can think of when it comes to energy policy, when it comes to obviously their central bank policy. So Hendry’s law, bad policy drives out good policy. What do you think? I’ll send it to you on the Euro.
Hugh Hendry:
Well, the wealth of Europe is largely the northern countries concentrated around Germany, and they pursue a Mercantilist policy. Where, again, this is a change, remember, the model of international trade, which largely is the infrastructure which determines asset prices, I believe. But it changed 25 years ago with the advent of closed capital accounts. And it changed owing to the Asian tiger crisis of 1997, 98 when overseas money was pulled and it led to substantial devaluations in the currency. But more importantly, it led to the eviction of collectocracies that had controlled those economies for decades. So the last 25 years is… This is a modern and very corrosive change in global affairs. Europe pursues something very similar whereby it is trading goods and services produced in Europe, and in return it’s willing to exchange the purchase of US financial assets. It is really not desperately keen to consume US goods and services, and therefore it runs a persistent trade surplus, and it reinvested savings in the US. So Europe, and particularly Germany, works on… If Germany didn’t have the Euro, the Deutschemark would be considerably higher than it is today. So it’s a disguised currency devaluation, just similar to the fact that 30 years ago China was the same size as Turkey in terms of its GDP.
Hugh Hendry:
It was just under a trillion dollars. They made a lot of smart capital allocations and knew they got a bit jiggery with capitalism. Their economy is 18 trillion. The laws of economics, which is one of the pursuit and the observation of equilibrium, ex ante, you would have expected that the Chinese currency had appreciated. The Chinese citizens had become richer, vis a vis the rest of the world. That has not been the case. If we go back to the beginning of… I’m losing the name of it. The free trade agreement between Mexico, Canada and the United States. The Chinese currency devalued. Prior to that, it was trading 6, and today it’s trading 7.3. It looks as if it’s heading to 8. That’s the hack that keeps their GDP linear and expanding. And it’s the hack which leads to inflation in asset prices and disinflation in wages for the real folk outside Wall Street. So to answer your question, I just see Europe as a modified version of what’s coming out of Southeast Asia, persuade from China.
BVN:
It’s all bad, but just different flavors of bad, which is what I’m hearing. Keith, I want to ask you a question really quickly about this de dollarization. We hear this all the time. It’s in the media. And do you think that part of this has to do with the Western financial media, who essentially love to glorify all these de dollarization narratives, but it’s only because the West and the dollar are incredibly transparent. There’s tons of data. Fred is a gold mine of information. While places like China or other countries don’t have this data, they’re not transparent, they’re incredibly opaque. And that is why all the bad things that happen to the dollar, which are much worse than other countries, are never talked about. Do you think this has to do with the type of media and obviously what we’re trying to disrupt here on the podcast?
Keith Weiner:
Yeah. I think you made my point for me that anything you want to know about the US financial system, the latest irregularities and how they indicted Trump, how the US military can’t account for a trillion dollars, every little bit of financial and nonfinancial mismanagement, corruption, blunders, policy blunders, what did Powell do? What should he have done? It’s discussed ad nauseam, every last fact, every bit of dirty laundry is hung out on the line for everybody to see. And that can give people, it’s not a recency bias, I’m not sure what the term for it is, where you’re so immersed in all this data and all this news that you think, you know, there’s a disproportionality to it. You think, Oh, my God. It really is that bad. And clearly the US and the US are in a descending spiral. But the question is, where are we in that descent relative to autocracies like China or Russia? And I think the answer is nowhere near, not yet anyway. But people blow it out of proportion. It’s like people read about car accidents, I’m sorry, airplane accidents, and they think I’m safe for driving. And they’re off by a few orders of magnitude in terms of the risk assessment is that far off.
Keith Weiner:
You get a similar thing here. Obviously, it’s not legal in Russia or China to talk anything negative about the government. I mean, that will get you arrested, disappeared to a secret police dungeon somewhere where they do unspeakable things to you for just saying negative things. And so there’s a lot less negative things being said, and therefore, what must be the US is worse.
BVN:
Hugh, I want to send it your way. You’ve mentioned that there’s pretty much three variables when it comes to GDP and GDP growth, which is productivity, population, and debt growth. Can you first of all explain those three variables and maybe discuss the US, China, Brazil, some other countries as to how you see those variables playing out and which of the three variables you think is the port?
Hugh Hendry:
Sure. That’s not my theory. That is economics, the three founding principles of where you generate economic growth. And for all nations, we know that as you get wealthier, the selfish gene within you doesn’t have to replicate because you are producing babies, etc. You’re producing less babies, forgive me, and therefore, population growth seems to decell the rate. The key to this is why productivity is not higher. I think that’s the real mystery. Productivity is really not contributing much to GDP growth. I would pose the thesis that productivity is very much a function of being front loaded by investment. There is no incentive for entrepreneurs to commit to capacity expansion. First of all, because capacity expansion in the continent of North America is at historical heights. Why is it at historical heights? Because China has amassed an enormous surplus of manufacturing capacity domest. The manufacturing capacity in China is by an order of two or three times greater than what a domestic market requires. That, if you will, leaches from the US. Secondly, the presence of the undervalued exchange rate makes China not more productive, it makes it cheaper, and therefore it’s conducting a begger, thy neighbor. If its labor force is cheap, then our labor force has to be cheap to compensate and to keep the thing steady.
Hugh Hendry:
So as you make labor cheap, there’s a fallacy of composition. Every corporation wants to pay the least amount possible. Not everyone, but you could conceive of that conjecture. But if I’m paying you less, collectively, you are the population of the United States, and you’ve got less wherewithal. You’ve got less income to expand and purchase consumer goods and other goods and services within the economy. We live in a world of surplus savings and deficient demand, and that takes away from the incentive to invest. And without investment, you tend to find that productivity is mediocre. And economics is interesting because you can actually come up with rugish, what are deemed to be rugish ideas, which actually stand up. So the rugish idea is that actually if we turn around and we paid folks lots more money for their services, you would be paying them, you’d be paying your customers, and they would be demanding your product, and therefore you’d find your capacity utilization was getting tighter, you would seek to expand, you’d invest. And secondly, you’d be investing because you’re a greedy capitalist, you’d be going, Oh my God. My labor costs. Labor costs are typically two thirds of total corporate charges.
And if they’re running 10, 15 %, you bet you’re going to be investing in labor saving productivity mechanisms. It’s a bit like oil. The price inflation owing to the power of the cartel meant that the price was at such levels where you’re incentivised to create good or bad, the technology which has enabled the thrust of the Green Revolution, the decline in solar panel prices, et al. The impulse comes from component cost price inflation. It brings investment, investment brings productivity. That’s how I proceed. The tragedy is that every central bank is trying to subvert that. Every central bank’s explicit policy is to prevent wage price gains. That is a folly which is leading to the impoverishment of many people.
BVN:
Keith, I want to send it your way. There’s a lot of interesting things there. First, I do agree that higher prices, the cure to those higher prices is high prices. When a cost, let that be labor or something else, is high, that does incentivize lots of entrepreneurial efforts to find labor saving devices, whether that be technology or productivity improvements. So I do agree with that. But I want to talk about the third variable to the GDP growth, which is debt. And I want you to quickly just what is the marginal productivity of debt? Are we actually getting more juice for the squeeze when it comes to our debt? Because it’s growing exponentially. So when you hope that the GDP would fall right along with it.
Keith Weiner:
Marginal productivity of debt is one of those things that… It’s an old economic concept. Everybody who’s got an economic background knows or reasonably should know when you use a legal standard there, knows or reasonably should know about it. And it’s not discussed much. For a while, I don’t know if this is still true. If you search on that, my articles are on the top of the Google search results page, not because I’m not prominent, but because marginal productivity of debt is not discussed. So marginal productivity of debt is essentially how much fresh GDP juice do you get from each new dollar debt squeeze. And you should want that to be flat arising. And when you listen to mainstream, even folks on the fiscal conservative side, even folks on the supply side, they’ll talk about, oh, yeah, well, we just need pro growth policies. We’ll grow our way out of the debt. Okay, well, growing your way out of the debt would mean that marginal productivity of debt would be greater than one. That’s okay. Sure, the debt is growing, but the GDP is growing faster than that. And so that over time, the burden of debt is lessened in that theory.
But there’s a professional malpractice. It almost be like if a doctor said, oh, well, you have a fever, we’re going to apply leeches. And completely ignorant of the fact that leeches have been long debunked as any curative to fever. In fact, leeches probably carry with them bacteria that if they bite into you could actually cause a fever, I would imagine, let alone cure one. So if you look at and you plot marginal productivity of death, which is change in GDP divided by change in death, what you see over really long period of time is a falling trend. And the oldest data that I’ve ever been able to find goes back to around 1950. And at that time, I want to say marginal productivity of debt was in the 60 cent range or something. It’s been a while since I looked at the graph and falling, falling, falling, which in recent years huge volatility as we’ve had the crisis of 2008 and then the stimulus and it bends up and down, but the falling trend is still there, which means that no, you can’t grow your way out of this debt problem. There’s a different resolution coming and that growth isn’t going to be that resolution.
BVN:
Hugh, we’re coming near the end of the podcast here. So I want to ask you a fun, rapid fire question, and we’ll go back between you and Keith. I’ve got a list of Federal Reserve chairman and some other prominent people here. I’ve got Alan Greenspan, Ben Bernanke, Janet Yellen, Paul Voker, and J arome Powell. I’m going to start with you, Hugh. What drug or drink would the acid capitalist describe these different Fed chairman? So let’s start with Alan Greenspan. What drug or drink do you think Alan Greenspan was? How do you think of Alan Greenspan?
Hugh Hendry:
It’s very easy on these platforms to reach for hype and to use silly terms. They are public servants seeking to do the best, and their remuneration is somewhat modest. They have no understanding. None of them has a competent understanding of money. None of them are the five. I know they try well. They are beholden to economy metrics and to models. They are beholden to the Phillips curve, which associates the relationship between unemployment and subsequent price wage, wage price inflation. Again, they are explicitly trying to destroy the livelihoods of ordinary folk. In the elections of the 1890s, there were two elections. William Jennings Brian, I don’t get his last name mixed up, but William Jennings Brian, he was a populist. The US had been enduring a deflation for almost two decades. And there was a very obvious and evident solution, which was an expansion of money, reintroducing a bimetallic standard and therefore replicating what was happening in other geographic locations. And silver was plentiful in the United States. Remarkably, he did not achieve public office. And of course, the lion and the Wizard of Oz represents William because he had this wonderful, scary oratory. But really, it was the witches of the banks of JP Morgan on the East Coast, which had the power.
Sadly, today’s somewhat similar, but he said, Please don’t crucify the common folk on a crucifix of gold or the crucifix of a hard money philosophy. All of the the term is that you cite still suffer from that dogma. Sorry, we’re trying to do quick fire, but that wasn’t so quick.
BVN:
Keith, I want to send it your way, which is I totally agree. We have the Fed running Econometrics. What do you think about this? Why don’t they just have enough equations, enough theories, and enough DHDs? You’d think they figured out the economy by now.
Keith Weiner:
Well, it’s interesting. First of all, the Phillips curve should have gone to the ash sheep of history in the 1970s when there’s supposedly this trade off between inflation and unemployment. I’m just old enough to remember in the late 70s and the nightly news, they used to quote something called the misery index, which was I think the sum or weighted average of inflation and unemployment, both of which had reached double digits and into the teens by 1979. And you said it was that they coined the term stagflation, which was meant to refer to the combination of stagnation, which is high unemployment and high inflation. You would think after that you’d throw the Phillips curve out and say, Okay, this thing totally doesn’t work. But no, they double down on it and they try to justificate it. I’ve written a lot of posts on Twitter about the monetists and their idea that, okay, if you double the money supply, you double the price level, MV equals PQ, and attacking that from different angles. And people say, well, the demand for money changed and this happened and that happened. I’m like, wait, you have this equation which you state as an equation as if it was the same thing as P V equals nRT, the ideal gas equation, and you’re stating this as an equation for the economy, when I point out your equation is wrong, you’re saying, Well, what had happened was, come on, it’s an equation or it isn’t.
If it’s an equation, it needs no handwaving and justification. So the very idea that you can model people as if they are particles of an ideal gas, that they are stateless, and also without consciousness, reason, or volition, that particles of an ideal gas don’t have any intentions. They don’t have any goals. They’re not trying to do anything or understand their circumstance. They just bounce around according to the laws of physics, whereas people do not. So the idea of an equation is it’s just wrongful from the get go. And so I’m with you in that I’m not so much blaming the man, whether it be Greenspan or Bernanke or whoever, but blaming the idea that we have these central planners in charge and that it’s possible to centrally plan us for our own good in the first place. That’s the real issue. And then the fact that they’re not getting it right shouldn’t be a surprise. Of course, they’re not getting it right. There’s no way for them to get it right. And not to mention on top of it, they don’t understand the monetary system. They don’t understand the fire with which they’re playing anyway.
Hugh Hendry:
Yeah, I mean, Keith nailed it. Well done, Keith. The irony, the paradox, the Gérard des Vs is all of that. The American economy has a very excellent system of determining interest rates or guessing at the natural rate of interest. It’s called the yield curve. And it does a great public service because when the feds, which is really just trying to appoint a new Pope every six weeks of the year, why 12 people are better than thousands of people who are subject to commercial risk and are trying to hedge themselves? Why they should have more wisdom is a fallacy. But the fallacy is revealed periodically when they overstep the market. Inversions tell the Fed, but the fed is not listening. So the fed, first and foremost, is the bank regulator of onshore US banks. I wish we could return it to that function and throw in the Bacot principle that there will be times like human beings where you’re bonkers. Again, there’s so many conceits and arrogance, but the notion that we’re smarter than our predecessors, I would push back upon it. We’re subject to highs and lows in terms of expectations and emotions. And so there is a need for it, for a centrally pooled resource that can actually have liquidity and can buy good assets at moments of distress.
Even then, I would take that away from the Fed and I would suggest that it’s operated by the treasury. I would try and address one of the great sins of the modern day, which is the profound disenfranchised population in America and elsewhere disenfranchised in that they do not own financial assets. They are beyond their reach, which itself is a function of mercantilism. But I would ask the treasury to impose a withholding tax on sovereign accumulation of dollar assets. With that, I would try and outfinance US sovereign asset fund that would stand ready to buy the stock market and other securities in moments of distress, that that fund’s allocation to that fund would be means tested, and therefore it would be owned by the disenfranchised and make our society more inclusive.
BVN:
Hugh, I want to ask you a final question before we go. First is, we have a lot of people on the Gold Exchange podcast. We’ve had Brent Johnson on, we’ve had obviously Mr. Snyder on as well. So can you ask a question that I should be asking all future guests?
Hugh Hendry:
Have you managed money? How long did you manage money? What is your mechanism for dealing with those many, many instances when you’re wrong? All of the above.
BVN:
Absolutely.
Hugh Hendry:
Yeah. I mean, you know. Yeah, just keep it short.
BVN:
Have you put your money where your mouth is from Hugh Hendry? Hugh, where can people find out more about acid capitalism and more Hugh Hendry?
Hugh Hendry:
On Twitter, Hendry_Hugh. On YouTube, Hugh Hendry official. People, be careful. There are so many scusballs and crypto exchanges. Go the SEC, let’s take them out. Let’s regulate the trading of securities. Then I do the acid capitalist podcast. I’ll be releasing tonight. We released typically on a Friday and we have a patron service. Patron members at the higher end get a 40 minute interview with me and various group chats, etc.
BVN:
Hugh I want to thank you so much for coming on to the Gold Exchange podcast. If you’re ever in Los Angeles, we’re going to have to buy a drink and have fun in Saint Bart’s. Thanks so much.
Hugh Hendry:
I am always in Los Angeles. Hollywood is my favorite town, so for sure, let’s meet up. And Keith, wonderful actually. It’s nice to cross swords with intelligent counterparts, so well done.
Keith Weiner:
Yeah, you too. I appreciate the chance to meet you.
BVN:
The drink is on me. I don’t know if they’ll let me pay in gold or not. Probably not.
Hugh Hendry:
Probably not. But we’ll drink tequila.
BVN:
I will drink tequila. Absolutely. I will drink tequila. Yeah, you’ll be drinking tequila. And are you on Saint Bart’s right now? Yeah. Love it. All right. Well, maybe I’ll come back to come out the same parts in my travels.
Hugh Hendry:
Hey, I’m hosting a conference on the 21st of August. You get to stay. I’m going to be your host. Come and live in one of the most beautiful houses in the world, and we’re going to talk macro. You can come for a $1,000. It’s three days. I’ve got a concier service and I’ll get you an Airbnb. You can come and stay with me. That’s a whale event. It’s 25,000 bucks. Sorry, people, but I mean, property here is proportionally expensive. Then there’s a Sunclub membership, which is somewhere in between 10,000 dollars. It’s expensive, but if you’re looking to hang out with some of the smartest people and enjoy one of the most beautiful places in the world.
BVN:
I think it’s worth the price. Everyone should go see Hugh on Saint Bart’s. Hugh, thanks so much. And we’ll have to come down there and get a little tan going. Get Monetary Metals, an office down in Saint Bart’s. Keith, what do you think?
Keith Weiner:
Absolutely!
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