On today’s show, we bring back a guest that often yields some of the biggest praise from our listeners. His name is Richard Duncan and this is the third time we’ve had him on the show. Richard comes with a wealth of knowledge and over 30 years of experience working for organizations like the World Bank, the IMF, large-cap asset management companies, and many more. He’s the author of three incredible books that discuss macroeconomics and how the world of finance functions in a fiat world.
During today’s discussion we’re going to talk about the bond market and how it’s yield is potentially creating an environment for the stock market to potentially go even higher. Richard outlines some interesting points about how central banks are going to act in 2018 and what that means for overall market movements. So with that, let’s roll.
In this episode, you’ll learn:
- Why and how the bond yield curve can signal a stock market high
- Why the FED is shrinking its balance sheet with 1 trillion dollars
- Why US’s trade deficit is the reason why the US dollar is the world’s most dominant currency
- Where commodities are heading in 2018
- Ask The Investors: How do I avoid confirmation bias?
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Podcast Transcript and Summary (automated)
Preston: [00:01:08] All right everyone, welcome to the show. And we are very excited to have Richard Duncan back with us. Richard this is the third time you’ve been on the show and we’re really excited to have you back.
Richard: [00:01:18] Preston thank you very much for having me back. I’ve really enjoyed the last two conversations we have had.
: [00:01:23] Well it’s likewise and I know our audience really enjoys hearing from you. You know we wanted to start off this episode talking about some current events and since Stig and I have been doing the show the market was really flat for maybe the first year and a half two years and then recently in the last year the market has just been going crazy here in the United States. It’s been going up a lot. And when we look at maybe some of the reasons why it continues to go higher. An argument that a lot of people are making is related to the bond yield curve. So before we get to the question let me explain what the bond yield curve is to the listener so we can kind of level set everyone and we’re on the same playing field here. The bond yield curve is nothing complicated. All it is is it’s a chart where you have the interest rate over on the y axis the up and down and then on the left to right is the term of the bond. So short term bonds are over on the left side of the chart as you go further to the right on the chart. You got your 30 year bonds out there. And so when you would picture how this chart would look it’s positively slope so down on the or at least it is today over on the left side of the chart the line is lower. And then as you go to the right it goes up and it gets higher and higher because your 30 year bonds are have a higher yield and your short term bonds that are just one month out there.
: [00:02:45] And so when we talk about a bond yield curve when you get close to a recession or a stock market high historically the bond yield curve has become flat where during the last recession a three month note was at five and a half percent and the 30 year Treasury was also at five and a half percent. And so that really doesn’t make much sense that your short term money would be at the same or return that you’d get on long term money. And what this does is it caused a lot of problems for banks with the way that they managed their liquidity. And so back to the original question here and I know this is really long and I apologize Richard but I’m trying to make sure everyone’s on page here with what we’re talking about a lot of people were saying that the market’s not going to have a correction until you see the bond yield curve start to go flat or the short term rates and the long term rates are at parity with each other. Do you agree with this narrative. How much more do you think this could move. I guess what are your thoughts on the bond yield or you think that that has any impact on the stock market.
: [00:03:47] Yes I do think it does.
: [00:03:48] I mean as you said traditionally when the yield curve inverse that most of the time is followed by a recession. So it’s considered an important leading indicator for the economy. Now the long end of the yield curve the long term interest rates are at a 10 year government bond. The most important one that is something that the Fed typically cannot control but the big question is is what is going to happen to the 10 year government bond yield. Right now the 10 year government bond yield is about two point four percent. Now is it going to go lower or is it going to go higher. Well if it goes lower then the yield curve would invert and that would suggest that there would be a recession but it’s not at all certain in my opinion that it is going to go lower. In fact it seems to me more likely that rather than yield curve inverting going to start seeing the 10 year bond yields start moving higher also. Why. Because the Fed is reversing quantitative easing. So instead of I think your listeners are familiar the Fed for a long period of time created money and bought government bonds. And when they did that that pushed up the price of the bond. And they’re still at very low levels but now rather than printing money and buying bonds and pushing interest rates down that is doing exactly the opposite. They are essentially selling bonds.
: [00:05:15] It’s a little bit more technically complicated than that but the effect is a sign you can say they are selling bonds. So when they sell the bonds that tends to make the bond price go down and interest rates go up. So starting in October they started reducing their bond portfolio by 10 billion dollars every month and now starting in January they’re going to reduce it by 20 billion a month. Then starting in April by 30 billion a month. And then in July by 40 billion a month and by October 50 billion a month. So that’s going to be extreme monetary tightening selling so many bonds will depress the price of the bond and push the interest rates up on the bond. So the long term interest rates should move higher rather than moving lower and also along the same lines. Right now in Europe starting this month instead of printing 60 billion euros every month ECB is only going to print 30 billion euros every month. And then in September they may stop printing altogether. This will stop putting downward pressure on European and U.S. interest rates. In other words global monetary position is tightening because the Fed is reversing quantitative easing and the European Central Bank is doing much less quantitative easing. So the government bond yields the 10 year government bond yields in the U.S. should move higher and the yield curve shouldn’t invert very interesting.
: [00:06:44] So now when we go back and we look at what they did in it leading up to the 2008 crash you know call it from 2007 ish on they were just adjusting the federal funds rate.
: [00:06:56] There was none of this quantitative tightening occurring correct well yes just before the crisis began in 2007 they had never printed money on a scale that they did. Once the crisis started and quantitative easing started it just tended to move the short end of the yield curve by moving the federal funds rate up and down.
: [00:07:17] So the reason I bring this up and I ask a question is because in the past typically we’d see the bond yield curve invert as the short end of that would start coming up you would almost always see the launch and start getting bought and brought down. Bring it to parity. So what happens from an equity standpoint now if the whole yield curve is just all going up and it still stays positively slope. I guess we haven’t ever seen that in the last thirty five years. So what does that do to the equity market since we haven’t seen something like this.
: [00:07:53] Well so just thinking about the long in the 10 year bond yield it’s now two point four percent which is very very low historic standards. For instance back in 1980 it or 81 when interest rates peaked at the time of the great inflation in the U.S. 10 year government bond yield was 15 percent. So starting around 1981 those bond yields came down and down and down until they are where they are now at two point four percent. And as the tenure government bond yield I believe is the most important number in the financial world. Because all of the other interest rates are set off whatever the 10 year bond yield is plus some premium. So mortgage rates are determined by the 10 year government bond yield consumer credit is credit cards car financing everything is based off ten year government bond yield. Now as interest rates came down from 1982 up until now. And so they borrowed more and spent more and as they spent more that created economic growth and that drove the U.S. economy for decades and the booming U.S. economy drove the global economy for decades.
: [00:09:03] And so the ratio of total debt GDP in the United States in 1980 debt to GDP. Total debt to GDP in the debt of the entire country as a percentage of the size of the economy it was 150 percent. But now it’s risen to 370 percent meaning that debt and credit have been growing much more rapidly than the economy. And fueling economic growth in the U.S.. So now if we began to see that 10 year government bond yield and move substantially higher say if it moves past 3 percent 4 percent starts moving about 4 percent because of quantitative tightening then credit is going to become much less affordable and the Americans will have to borrow less and spend less. And that alone will be sufficient to make the U.S. economy go into recession and making all of that worse is the fact that as interest rates move higher then stocks will become less attractive and property will also become less attractive. If the mortgage rate goes higher then people will not be able to buy homes.
: [00:10:12] So home prices will fall and stock prices will fall. You’ll have a negative wealth effect and so the Americans will not be able to spend as much because their homes and their stock portfolios will be less valuable.
: [00:10:25] So Richard could you talk to us about the different rates you’re talking about the Federal Funds Rate talked about the 10 year on deal like how can we look at this and perhaps the way to go about this would be what is controlled by the Fed and what is controlled by the market. How do these two interact.
: [00:10:44] So yes it controls the federal funds rate and so if it hikes the federal funds rate in the short term interest rates will go up along with the federal funds rate. So it has direct control over the short term interest rates to be a bit more technical.
: [00:11:02] Right now all the banks have bank accounts with the Federal Reserve System and they have a lot of excess reserves piled up in their accounts at the Federal Reserve and the Fed is now paying interest to the banks on their reserves the reserves of the commercial banks are holding at the Fed. So the Fed is paying an interest rate now of one and a quarter percent on those reserves along to the banks.
: [00:11:34] So the banks are not going to lend anyone any money or less than one and a quarter percent because that’s how much they can earn from the Fed by just keeping their money risk free on deposit at the Fed. So that’s how the Fed controls the short end. They’re paying interest on the deposits that the banks are holding at the Fed. And there are lots of loss of deposits there. So when the Fed next wants to increase interest rates they’ll just pay the banks one and a half percent and then one in three quarters and then 2 percent. And so that will determine the short end of the yield curve. The banks will not lend anyone the lower rate. So the Fed has direct control over the short end and that way at the long end is much more complicated along in depends on a lot of factors. For instance supply and demand if the economy is weak then that suggests that there are very few investment opportunities. So people tend not to want to borrow. And if people don’t borrow and interest rates tend to fall on the other hand if the government has a very large budget deficit and of course the U.S. does have a large budget deficit and it’s going to become larger because of the tax cuts just passed. If the government borrows much more all other things being the same it tends to push interest rates up. But you get still another factor is what’s going on with the central banks outside the United States.
: [00:13:07] For instance China China has the largest central bank in the world now it’s larger than the Fed in terms of its asset size. So for quite a long period of time for a couple of decades the Chinese central bank the People’s Bank of China see it was printing its own currency it was printing yuan and it was buying dollars in order to prevent the yuan from appreciating. They didn’t want their currency to appreciate because China wanted to continue growing through export led growth. So altogether China created the equivalent of something like four trillion U.S. dollars and used most of it to buy dollars. And once they had accumulated the dollars invested those dollars into U.S. government bonds because they bought the dollar in their exchange rate from going up so that their economy could keep growing through export led growth. But once they acquired the dollars they needed to invest them somewhere in order to earn interest on them and they invested in U.S. government bonds that push their yields down. Now in fact it pushed them down so far that it blew the U.S. into a bubble during 2004 5 6 they were printing so much money and buying so many dollars and buying so many U.S. government bonds that the Fed lost control of interest rates and the U.S. economy bubbled long into the yield curve and the Fed can’t control them all.
: [00:14:32] Does the Fed sit on a lot of the bonds on the long end of the yield curve.
: [00:14:36] With respect to what they did with the operation twist when the Fed started its quantitative easing it already had a lot of government bonds long term. You’re saying well some short and some long before the crisis the Fed already owned a trillion dollars worth of government bonds. At that point when they were buying these 10 year government bonds they did have a very strong control over the bond yields. In other words the more money they printed and the more 10 year government bond yields they bought a higher bond prices went lower the bond yields went. So at that time when during quantitative easing they had a very direct control over the yields on the 10 year government bond printing money and buying enough bonds to make those yields go anywhere they wanted. But they’ve stopped doing the quantitative easing.
: [00:15:29] Now I’m curious the numbers that you quoted what was it 10 billion 20 billion 30 billion was that correct. The bonds that they’re getting ready to put back on the market.
: [00:15:38] That’s right. They’ve published a schedule of their intentions of shrinking their balance sheet. And in the first three months of it shrank by 10 billion a month. The second three months by 20 billion a month and then 30 billion and 40 billion and then 50 billion a month.
: [00:15:53] So what does that equate to in yield. Are we expecting that to equate to anyone. Has there been any kind of analysis on that. Because at the end of the day I don’t know if that’s a meaningful amount relative to how many there are you know outstanding and what the market size and the band size is and what that might mean for price action. So I’m curious you feel like that’s a meaning amount.
: [00:16:16] Yes that’s a very large amount. Within two years that would shrink the Fed’s total assets by something like 25 percent they would reduce their size of their assets by more than a trillion dollars by adding 10 billion to the number every month.
: [00:16:34] That’s right. OK. Now the next question becomes. Because I mean we’ve seen how this Fed acted for the last four years and anything that they say they probably have to say ten times before they do want action. So what level of assurance do we really think we have that they’re actually going to do this.
: [00:16:55] Well they started announcing this I think it was back in June and they started doing this in October. So this program has already begun and it’s now moved from 10 billion a month this month they will contract their balance sheet by 20 billion. So we’re now at the 20 Dorrian level and this is taking 20 billion dollars. We always talk about the Fed creating money. This is what Fed retiring money or making money that exist now disappear. They’re making dollars disappear. They’re sucking dollars out of the financial markets and that means they’ll be less dollars left in the financial markets and therefore other things being the same asset prices should fall.
: [00:17:37] So Richard I would like to speak about a very related topic here when we talk about on bond yields and those different central banks here and I would like to start off talking about the U.S. dollar because as we covered with you in the previous episode you know it does enjoy a lot of benefits being the dominant currency in the world including persistent trade deficit and U.S. dollar also provides financial markets with a source of liquidity and foreign capital inflows. Now what would happen happened as we have seen it say gradually if commodities are being priced in all occurrences. And do you see this change to continue over the next few decades.
: [00:18:24] Yes I hear a lot of people now talking about the possibility that some day oil will be traded in some other currencies than dollars.
: [00:18:33] So I think that maybe what you’re referring to Mataji is being priced in some other currency. Most of these people are very keen. Gold bugs they either have enormous positions in gold or in some way they make money through encouraging people to buy gold. So I think you have to always take that into consideration when people are talking to you. You have to think about what they’re trying to sell you. And are they trying to sell you gold. Of course if they are they’re going to make arguments that will support that even though the arguments may not be so strong. The reason the U.S. is the reserve currency of the world is because the United States has enormous trade deficit every year roughly this year will be something like a half a trillion dollars. That means countries like China sell their goods in the United States and they get paid in dollars and they take those dollars home. And so that the current account deficit it has five hundred billion dollars this year and is going to throw out five hundred billion dollars into the global economy and that will be five hundred billion dollars more than there were last year.
: [00:19:43] And so the U.S. has had an enormous current account deficit now going back to 1980. The world is absolutely drowning in dollars. Their dollars dollars everywhere. Now that’s the reason we’re on a dollar standard. It’s not as though if China suddenly decides to buy oil from Russia and pay for it in our M.V. Chinese currency instead of paying for it with dollars that’s not going to have very much of an impact. What that means would be that Russia instead of getting dollars Russia would be paid in a Chinese currency and they would have to do something with that Chinese currency. I buy Chinese government bonds and they really don’t want to do that because it’s a very risky investment. So maybe they will maybe they won’t. But the U.S. is never going to start buying oil denominated in R and D or anything other than dollars. So as long as the U.S. continues to have such an enormous trade deficit the dollar will continue to be the global reserve currencies just simply because there’s so many dollars in the global economy. China on the other hand has a very large trade surplus.
: [00:20:53] So it’s not throwing any new Chinese currency into the global economy. Relatively speaking in order for the R and B to become a more of a reserve currency China would need to run a very large trade deficit like the U.S. does so that other countries would all Noren be. But that’s not happening and it doesn’t look like it’s going to happen anytime soon. So we’re going to remain on the dollar standard or into the future as far as I can see.
: [00:21:17] Can the market lose faith in us because I guess like for people listening to them they would say oh we just need to have a of deficit and the block to the deficit the more our currency would be a dominant currency it might seem counterintuitive but we have with the mob would simply lose faith in US dollar buy them well in order for China for instance to have a trade deficit that would mean that it would have to buy a lot of things from other countries and if it bought a lot of things from other countries it would no longer be able to keep all of its factory workers employed because it would be buying fewer things domestically.
: [00:21:52] And suddenly China’s unemployment rate would go up to a very high level and there’d be social unrest in China. So China is not going to flip from a massive trade surplus to a massive trade deficit anytime probably within our lifetimes. So that’s not going to happen.
: [00:22:07] Now China’s central bank probably already has somewhere near three trillion dollars in dollar assets that they hold primarily in U.S. government bonds. Now people say well China could just suddenly dump those bonds and that would be the end of the dollar standard. What does that mean. Dump the bond. It means they have to sell them. Are they going to sell them to the Dutch investors or to Middle Eastern investors to Russian investors. It doesn’t matter what they sell them to. Those people are then going to have dollars and they’re going to have to keep their dollars invested in U.S. Treasury bonds. So there’s no easy way to crash the dollar standard. If you sell dollars It’s like selling farmland and sell farmland it doesn’t disappear someone else owns it. It’s the same with dollars.
: [00:22:52] After listening to you after this sustainability of a dollar based system the one that we have right now.
: [00:22:59] Does it mean that it will become less problematic in the future or do you think that there is a alternative solution to the current monetary system that we have I don’t think that there is an alternative to the current system that we have a lot of people talk about the possibility of returning to a gold standard or an SDR standard. And let me explain why that would have disastrous consequences. For instance if we were to go back to a gold standard then that would mean that the United States would have to buy all of the things that imports and pay with gold as it used to have to do when we were on a gold standard. So the United States only has so much gold and it has a very large trade deficit especially with China. The United States trade deficit with China is one billion dollars a day. So it wouldn’t take very many months of one billion dollar a day trade deficit. If we had to pay with gold United States would run out of gold very quickly. That would mean that it could no longer buy anything at all from China. Therefore China’s export driven economy which is already suffering from extraordinary excess capacity across every industry. If it suddenly was no longer able to have a trade surplus of a billion dollars a day with the United States and China’s economy would absolutely implode in such a spectacular manner that mankind has never seen before. So the last thing China wants is to return to a gold standard or any other standard that does not allow the United States to buy things from China that the rate of a billion dollars a day in terms of a trade surplus fiat money allows countries like the United States to buy things on credit and that benefits the sellers. So the sellers are very interested in ensuring that the fiat system continues. They’re not at all interested in wrecking it because they understand it would destroy their economies fascinate.
: [00:25:00] All right so Richard we’re curious is there anything that you have a lot of people have a narrative that they like this gas or something that’s you know we just started 2008. It’s a brand new year. Is there something that maybe you’ve been working on or that’s something that you’d like to discuss. That’s near and dear to you.
: [00:25:20] Well two things I mean in terms of what I think is important. We’ve already touched on that. What really matters most. I leave for this year in all respects is what happens to interest rates because we now have the Fed is reversing quantitative easing. They are shrinking their balance sheet. This is radical monetary tightening. And the same thing is beginning to occur in Europe. And so we’re moving from a period of extreme loose monetary policy to what can only be described as radical tightening. Now of course before things run out of control they would stop on State of tightening they would stop pause. And if things really started to crash too violently and they would launch another round of quantitative easing again they would have QE 4 to push them back up. But the risk is that at the very least we could experience quite significant volatility in the stock market and the financial markets this year as the Fed test the markets to see how far the Fed can go in terms of creating money without creating an economic and financial sector crisis that’s the big theme.
: [00:26:30] Richard how much do you think is self reinforcing in the sense that you are contracting the money supply and the market respond but because perhaps the mind will respond you’ll see how like a snowballing effect. Is that something that you expect to happen.
: [00:26:45] Well yes. Once the stock market starts to fall I mean for instance if the stock market falls 10 percent and looks like it’s going to keep falling then I would expect the Fed to stop the quantitative tightening put it on pause and if the stock market were to fall 20 percent I believe the Fed would launch another fourth round of quantitative easing and push it back up. So you have no doubt about it. The Fed is managing the economy by the amount of money they are creating or destroying and they don’t intend to allow it to crash. But at the same time.
: [00:27:19] They’re now acting we have to look at when all of this fiat money system started and why it started it’s been going on for decades. For instance in World War II at that point the government had to take over complete control over the economy to fight the war. It issued enormous amounts of government debt and the Fed financed it. It was a very important role the Fed played in allowing the United States to win the war. And ever since World War II the government has managed the economy with the help of the Federal Reserve.
: [00:27:56] And during this times even since the early 70s when the Bretton Woods system broke down afterwards money was no longer backed by gold in any way. And this allowed an extraordinary explosion of credit in the United States and all around the world for the next several decades. And that explosion of credit literally pulled hundreds of millions if not billions of people out of poverty all around the world. It created the world we live in. Everything in our modern world is a result of shifting from a gold standard of fiat money standard and the explosion of credit followed it to the world has been transformed by the system. The problem is in 2007 the United States got to the point where it was so heavily indebted private sector that they couldn’t continue borrowing anymore in fact they couldn’t afford to repay the debt that they had already borrowed.
: [00:28:52] The households started defaulting on their debt. And at that point the financial system started to fail. And if the government had not intervened then all the banks in the United States would have collapsed and all of the savings not only in the U.S. but all around the world. Entire global financial system would’ve collapsed all the global savings would have been destroyed.
: [00:29:13] It would have been a complete meltdown of the global economy with the most likely outcome would have been widespread starvation. So this time they reacted in a completely different way than they did at the time of the Great Depression the time of the Great Depression the Fed was already in existence. And it didn’t print money on an enormous scale and reflate US economy. It could have it didn’t this time Ben Bernanke who had studied the Great Depression believed that if the Fed printed enough money and bought enough government bonds it could reflate the economy make all the banks solvent again and prevent a new Great Depression. That’s what he believed. He tested out his theory and he was right. You did reflate it. So we haven’t lapsed into a new Great Depression. However the global economy still remains a very big bubble. It’s a bubble because there’s too much credit in the world relative to the income the amount of money that people actually earn. There’s too much debt and not enough income to service the interest on the debt among the private sector. So that really means that only the governments have the ability to borrow and spend more aggressively to keep the global economy from shrinking perhaps spiraling into a downward depression.
: [00:30:41] And so that’s why the U.S. government had to increase its debt by 10 trillion dollars over the last 10 years and they were able to do that because the Fed monetize one third of it. The Fed essentially bought up three and a half trillion dollars out of the 10 trillion dollars of new government debt that the government issued. So it was this combination of government spending being financed by paper money creation that prevented us from replaying the 1930s. So in this respect the Central Bank played a very crucial role not only in financing World War One and World War II and the cold war but this time in preventing this Ffion money system from imploding into a new Great Depression. The question is is what policies will we have now to ensure that the economy doesn’t once again experience a financial sector crisis the way that it did in 2007. Given that the private sector is still very heavily indebted and really can’t continue taking on more debt.
: [00:31:44] So Richard is it really evident listening to you how the money supply is controlling so many different parts of the economy. Which time period would you say is the time period with monetary policy the least and most significant impact.
: [00:31:58] And why is that so. That is a complicated complex question that really requires a very long answer I think.
: [00:32:08] But I would say that the time when the Fed was least effective was during the early first few years of the 1930s when it didn’t take actions to stop the bank failures.
: [00:32:23] In 1933 when President Roosevelt took office the banking crisis was so systemic that he declared a national bank holiday and closed all the banks in the country. By the time they reopened twenty five percent of them never did reopen. So that was a time when monetary policy was the least effective because the people running the monetary policy didn’t know how to work it at the time a time when it was most effective was during World War One and World War Two. It allowed the U.S. government to borrow as much money as necessary to fight and win the war. And the Fed printed the money necessary to finance government borrowing and allowed the government to borrow at very low interest rates. And where do you think we are in that given the current conditions that we have now is muncher policy effective today compared to history so you could say that in a sense the crisis of 2008 and the Fed’s response to it was almost the same sort of pattern that occurred during the two world wars. There was a crisis the government had to borrow in this case ten trillion dollars to ensure that this crisis didn’t overcome our country. And the Fed made that possible by printing three and a half trillion dollars and buying government bonds and holding the bond yields interest rates at very low levels so that the economy could be replated.
: [00:33:50] So it was a very effective policy. And here we are nine years later unemployment rates 4 percent the household sector net worth in the United States is something like 40 trillion dollars higher now than it was in 2009. It’s gone up 75 percent the wealth of the country as a whole. The Americans all their assets minus all their debt as household sector net worth. It’s now 40 trillion dollars more 75 percent more than it was in 2009. And at least a third more than it was in 2007 before the crisis started. So the policy has been very powerful and the only reason that they’ve been able to get away with this printing three and a half trillion dollars in the U.S. and now Europe is printing very aggressively. Japan is printing very aggressively. The reason they have managed to get away with that this time is we have a global economy and because we have a global economy the global economy is very deflationary is deflationary because you no longer have to pay someone in Michigan two hundred dollars a day to build an automobile you can now pay someone ten dollars a day in China or Vietnam.
: [00:35:04] And so the cost of labor has collapsed. In the past we had relatively closed economies. So at the Fed printed a lot of money and very quickly all of the workers would have jobs. And so wages would start going up sharply and all of the factories would have full capacity utilization. And so their prices would go up and we would have a wage inflation spiral that led to very high rates of inflation and even hyperinflation. What has changed now is we no longer have closed domestic economies. US just doesn’t buy cars built in Michigan us can buy anything it wants anywhere in the world it wants. And in this world we live in two billion people live on less than three dollars a day. So that means we have generations of extremely low cost labor that allows the government to have much more government spending and allows the central bank to have much more paper money creation and would have ever been possible before globalization began around 1980. Now we have a big global economy with enormous excess capacity and a pool of extremely low cost labor. So that explains why there’s no inflation. Despite all the paper money it has been created.
: [00:36:19] So I’m kind of curious how that plays into commodities moving into the coming year. A guy that we track pretty closely billionaire Jeff Gunlock he’s suggesting that commodities are going to do really well here in 2018.
: [00:36:32] Would you agree with that idea when the dollar goes down commodity prices go up when the dollar goes up commodity prices go down. Look throughout history there’s a very very solid correlation. So what’s likely to happen of course between or around the middle of 2014 and the first quarter of 2015 I believe the dollar became very much stronger and that caused commodity prices all around the world to fall very sharply. And that was the period when oil went to 26 dollars a barrel and that did extreme damage to the commodity producing countries like Brazil and of course to their currency values. It also caused damage to a lot of corporations around the world who traded in commodities or are involved in mining or oil production. So their corporate profits fell and therefore their stock prices fell. But now the dollar is stabilized for a while and at the moment very mysteriously it’s weakening. It’s actually the dollar is becoming weaker over the last several months and as a result oil is moving higher and gold is moving higher. Now for me I can’t understand why the dollar is weakening because as I’ve said the Fed is now conducting a very aggressive monetary tightening by reversing quantitative easing and withdrawing dollars from the global economy fewer dollars there are in the global economy. Supply and demand if there are fewer of something it becomes more expensive. So the dollar should appreciate but instead the dollar is weakening but I still believe that as the Fed continues with this tightening schedule where they will be removing 50 billion dollars a month destroying 50 billion dollars a month starting in October that should cause the dollar to strengthen and if it does that it’s going to cause gold and oil and all the other commodities to fall.
: [00:38:29] All right Richard we are so thankful to you. Time to come on the show. I know every time you come on I learn a ton. I’m speaking for steak but I’m assuming it learns a ton right there with me and he smell anything. Yes. Yeah but you know we want to give you an opportunity we know that you’re currently working on a video that you’re going to have available on your macro Watch website that goes through the history of the Fed. It also goes through the history of monetary policy. It sounds fascinating. Tell people a little bit about what you’re doing there and then also tell people about your site Macra or what.
: [00:39:04] Ok. Well let me just say to begin with I always really enjoy coming on this program you guys are such good questions and allow enough time that we can really go into these things in enough detail to make them make sense to anyone listening.
: [00:39:17] So I really enjoyed being on your program. Thank you for inviting me again. You know as you know I publish a video newsletter called macro watch. And every couple of weeks I upload a new video which is essentially me doing a PowerPoint presentation describing something important going on in the global economy and how that’s likely to affect the stock market and the bond market interest rates commodities and currencies. Well this time I’m working on something I’m really excited about. It is a complete history of the Fed and therefore a history of U.S. monetary policy starting from the time the Fed was established in 1914. And what I have done is I’d break this into seven different periods and for each period there are two charts that I discuss. One shows how much the Fed’s assets increased during that period. Which tells us how much money they created and the other chart shows how the composition of the Fed’s assets and liabilities changed during that period. And by looking at the change in the makeup of the Fed’s assets and the change in the makeup of the Fed’s liabilities it tells a complete story of how the Fed evolved. Initially the Fed was just intended to be relatively passive institution that would serve to prevent banking sector crises. There had been a very severe banking sector crisis in 1997. And so in order to prevent that from recurring. Congress created the Fed in order to act as a lender of last resort in times of banking crises. But it wasn’t intended to be a very active institution it was just going to take a passive role.
: [00:40:59] But the very same year the Fed started operations. World War 1 began and that completely transformed the purpose of the Fed. Suddenly it was no longer passive. It became very active because it had to finance governments or expenditures war debt and so on. By going through seven periods and looking at the way the Fed’s assets changed that tells us the history of the US monetary policy and that’s extremely important because now the Fed is the most important instrument along with us government debt and the way that the United States government manages our economy. Governments manage economies now. Laissez Faire was something that was happening in the 19th century. It has very little relevance to our world now the governments manage the economy. You want to understand how they’re managing it and what that’s likely to mean for your investment portfolio and your investment strategy. Then you have to understand monetary policy. So I would like to offer your listeners a 50 percent discount to a subscription to Makro watch Makro watch cost five hundred dollars a year. But if you visit my website which is Richard Duncan economics dot com that’s Richard Duncan economics dot com go to the Web site book on the Subscribe button. It will ask Do you have a coupon code if you use the coupon code. History and history will give you a 50 percent discount so that will give you a one year subscription for 250 dollars worth that you will get one new video every two weeks plus you will also have access to.
: [00:42:39] Now there are already hours of Nacro watch videos on the macro watch our cars which you can begin watching immediately.
: [00:42:46] So I hope you take a look.
: [00:42:48] Great handoff Richard. And again thank you so much for coming on the show.
: [00:42:53] All right so this is the point in the show where we take a question from the audience and this question comes from Jati press.
: [00:42:59] This is history. The Shirley Dean from Jakarta Indonesia. Italy listening Tullio of for a couple of years now I’ve learned so much from you guys. Thank you for the great. Well you guys are doing a good thing for us. One thing that I really appreciate about you guys is how open minded you are to coalesce and investing option even though I know Warren Buffett won’t touch school at all. So my question is how do you guys stay open minded to new ideas so that you can make the best investment decisions.
: [00:43:36] Thank you. I mean this one’s really easy for me. I’ve just been wrong so many times that I have to be open minded. You stay home you’re yours.
: [00:43:46] Oh I know be wrong at least as many times as you Preston. One thing that I would like to take away from this discussion asked What’s your thought process whenever you start doubting yourself. And one thing that I think I’ve learned from studying all these billionaires is how you should see the advice say the case for someone who is bull and vice versa because those arguments that you will find from people who really believe something still can pinpoint something and can go wrong. There are typically a lot more artful. There is nothing more waste of time than if you meet someone who is saying this is the best thing in the world. These are the arguments why the best thing in the world and there are no downside whatsoever. Chances are you can use the arguments for anything is probably not that high. So that’s the first Punam response. The other thing Bob Warren Buffett and how he’s talking about gold. I think Warren Buffett is very open minded but I think he’s very open minded in his own Neish. This is Equitas if you just think about you know the storia whenever he met Bill Gates and Gates talked about these amazing questions that he never got about his company from anyone else. Specifically Buffett you know asked syllabled question like who the biggest rival and why and what you’re doing better than you are how much cash do you keep on the balance sheet and why do you keep that level of cash. Exactly and what you’re attuned to cost of that. So I think someone like Warren Buffett. Yes he is super super open minded but you probably won’t even invest in bitcoin or something else that he doesn’t know anything about because I think he’s also right that if you try to be a 5 percent expert in 20 different asset classes you’re probably not going to be successful in the first place.
: [00:45:32] You know one of the things that I think about a lot whenever I start developing a really strong opinion on something and I feel like I’m kind of getting in the military we call it Target fixation. That’s whenever when you’re flying a helicopter you get so fixated on a target that you’re coming down and you actually fly the aircraft into the target because you’re so fixated on it. And so I think for a lot of people whenever they invest sometimes they get a target fixation. Maybe they think the market is going to go down and then they’re right and then they just keep piling into it. We’re on the upside they keep piling into it as it’s going higher and higher and higher and they get fixated on the fact that they’re right and they stop asking themselves why am I wrong which goes back to the story of Ray Dalio. So we covered this when we talked about his book back in 1981 Ray Dalio literally lost everything. And let me tell you up to that point he was doing really well for himself. He was you know a master at derivatives and he was a master at commodities and currencies and things like that. And in 81 he had an opinion. He stuck with that opinion. He basically had convinced himself that there was no way he could be wrong and he was dead wrong. He lost everything. And I think about that because when I think of people that are really smart out there value is definitely one of the top people on the list. And the thing that I remember distinctly from his book is him saying I stopped asking myself why I’m right.
: [00:46:56] And I started asking myself why am I wrong. And having been wrong so many times in the market and different positions and things like that that is one thing that I can honestly say I’ve developed a keen appreciation for is always asking myself ok so why am I wrong. And how could this really turn into a bad position if I pile more money into this even though I’m ahead. And you’re always kind of got your guard up for being wrong. And I think that’s really important for people to develop that skill especially if you’re new to the markets and you know. I mean if you’ve been investing since 2010 all you kind of know is that the market goes up. So I would tell those people to be very careful and to really kind of start asking themselves how could I be wrong. All right sir Jodhi so thank you so much for submitting your question for submitting your question we’re going to give you a free course on our website. The IP Academy it’s our intrinsic value courseware teaches you how to go through and figure out the intrinsic value of a company. There is an Excel calculator with this it helps you determine the value of a single stock pick. And we’re just really thankful for people like you for submitting your question if anybody else out there wants to submit a question on the show and get it played. Potentially win a free course. Good to ask the investors dotcom you can record your question there and hopefully get it played on the show.