Preston Pysh (03:07):

Ed, you said that the IMF has forecasted that the public debt to GDP ratio of advanced economies would rise from 105% in 2019 to 132% by 2021. How will we as citizens experience the increased debt burden and what is the implications for the world economy?

Ed Harrison (03:27):

Yeah, I think that’s a good question because it was interesting that I saw a piece by Ambrose Evans-Pritchard of the Telegraph earlier today. He was writing about the problems within the Eurozone, and I think that’s a good place to concentrate when you think about what’s happening with regard to the debt situation, the public debt in particular, though I think private debt is generally the biggest problem that you have to worry about. The reason that I talk about the Eurozone is because when you think about debt, you think about the government because they have the ability to tax as having more wherewithal from a debt situation than private debtors.

Ed Harrison (04:06):

A private debtor, if bad things happen, it has to get revenue, it has to get customers to give it revenue, or it has to get income if it’s a person and that’s difficult to do. The government can just raise taxes. There’s a limit to what they can do in terms of revenue, but they have a lot more wherewithal as a result of that. Unfortunately, however, the Eurozone doesn’t have the exact same level of degrees of freedom, just because of the way that it’s structured. That is you have the European Central Bank on the one hand, and then you have all of the individual countries on the other hand, which are at a lower level. So there’s a disparity in terms of the centralized European Central Bank and then the individual member states.

Ed Harrison (04:53):

And just to give you a sense of what I’m talking about, this is what Evans-Pritchard says, he says that Germany, their public debt had jumped over 11 points to 71% of GDP over the last year. So the Maastricht Treaty had a 60% hurdle. Germany had been under that hurdle. They jumped up from 60 to 71%. So they’re slightly over the hurdle, but it’s not that big a deal. But then when you start looking at the other numbers, especially in Southern Europe, the numbers start to balloon up. An example, 116% for France, 120% for Spain, 135% for Portugal, 160% for Italy and a massive 201% for Greece. These aren’t numbers that are prospective, these are numbers that are actually already existing.

Ed Harrison (05:45):

And when you add in all of the turmoil that we’re having in this long, cold winter, again, those numbers are going to be even higher. So the question becomes what happens on the other side? When you get the vaccine, when you get the medical bailout, are you going to get the financial bailout to go along with it? And the answer for these particular economies is no. No, they will get the medical bailout, by the time that comes, the debt levels will be so high that it’s going to be a problem. So Europe is where I would look first and foremost for those debt problems to rear their head.

Stig Brodersen (06:20):

You talk about private debt and you talk about public debt and it’s very important to make that distinction. Very often you just say debt, but all debt are not created equal.

Ed Harrison (06:29):

First and foremost, with regard to public and private debt is where your revenues come from. And the second is, is also what kind of currency are you using? So I think with regard to the revenue sources, if you think about private debt, that is debt that’s held that is issued by, or that is owed by private entities, whether those are companies or individuals. So if you take out a mortgage on your home, you have to pay that mortgage back, that’s a debt that you have. In order to pay that back, you need to have revenue. And that revenue comes from income streams that are available to you. Mostly for most people, it’s their work.

Ed Harrison (07:04):

For companies, revenue streams are from business that they do. And they’re beholden to their customers, they’re beholden to making a salary in order to meet those payments. If you don’t have a job, or if your customers abandon you because it’s a recession, then those debts become more burdensome to you and there’s no way out of it. Basically, there might be a point at which you default. Government on the other hand, they have a much bigger cudgel. That is, is if the debts aren’t due, what happens is if they can’t make the debts because of their revenue, they can just raise taxes. They can always increase their revenue stream up to a certain point. You can’t get a blood out of a stone, but you can tax people more and more at some point and get money as a result of that.

Ed Harrison (07:57):

The second part of that I would say that’s the most important is the currency that you’re using. In the United States, in Denmark, in the UK, you are what are called currency issuers. That is, is that the currency is issued by the government. Effectively, the government can print as many Danish krone, as many UK pounds, or as many U.S. dollars as they want in order to make good on their debts. Effectively, the government debt is an IOU. That is, is, is that what you’re saying is, I know that you can actually make good by taxing, so I’m actually just going to take an IOU from you, knowing that it’s the taxing authority and you won’t abuse your position with me.

Ed Harrison (08:44):

I’m going to take this fiat money from you as if it’s actually something that you’re not going to abuse. The Eurozone doesn’t have that same opportunity. They gave up that when they created the Euro, the Euro is something that is mutually secured and is issued by the ECB. It’s not as if the Bank of Italy or the Bundesbank or any of the others can just print a bunch of Euro. The Fed has the back of the U.S. Treasury. We see that now, with regard to quantitative easing and other things, et cetera. There’s only so far that the ECB can go. So the likes of Italy, they’re going to be in big trouble once the pandemic emergency conditions are over and they’re caught with 170% debt to GDP.

Stig Brodersen (09:35):

Let’s focus on the U.S. here for a bit. Let’s talk about the public debt for the U.S., it has exceeded 136% already, and now with COVID, it’s just been growing rapidly. And you could even say it was growing rapidly before COVID. Paying down debt with current account surplus just seems unrealistic at this stage, which other options does the U.S. have available?

Ed Harrison (09:59):

The option that the U.S. has available in terms of the debt is to not pay it down, to grow out of the problem, or to have inflation erode the debt. UK, when they went into World War II, it decided, you know what, look, this is an existential crisis, we’re fighting the Nazis. We need to create armaments and have our soldiers ready and prepared to fight the Germans, we’ll do whatever it takes. And they did that. And by the time that the war was over there, they had 250% debt to GDP. This is under the Bretton Woods system, which was a modified gold standard. So ostensibly, that’s hard money. Yet, they were able to continue to pay their debts through both currency depreciation and through inflation all the way until today, without a default.

Ed Harrison (10:49):

They did have in 1976, a currency crisis, where they went to the IMF, but other than that, which was 30 years after the war, they were able to successfully deal with a mountain of debt, 250% debt to GDP, and do so successfully over decades. So the United States that’s to me, the likely outcome, that is a combination of growth, inflation, currency depreciation, will make it so that, that debt load as a percentage of GDP is lower 10, 20, 30 years down the line. What’s interesting is that at least in the short term, we could see a pop in terms of growth coming back to levels that are better than the so-called secular stagnation that we’ve seen, because lower for longer in terms of interest rates is a result of the fact that real growth has been very poor in the United States and elsewhere.

Ed Harrison (11:49):

So think 2%, instead of 3% or 4%. The country I would look at as an example of how that works over time, let’s say if you had three or 4%, would be Belgium. I’m looking right now, as we’re speaking at a trading economics website on Belgium and over the period from 1995 until the year say 2008, there was no period there except one year, the year 2000, that Belgium’s GDP increased by more than 5%. During that entire period, their GDP level was below the 5% per annum level. Yet when you take a look at the exact same chart from 1995 to 2008, their debt to GDP went down from 131%, debt to GDP, that’s about equivalent to where the U.S. is right now, where you said 136 down to 87.3%. And so, that’s obviously above what the Maastricht Treaty is, but they continued to go up after the sovereign debt crisis to 107 and then ended the year 2019 at 98.6.

Preston Pysh (13:09):

Ed, in the latest earnings call, JPMorgan Chase CEO, Jamie Dimon, was openly reflected on the potential double dip recession. Could you please take us through some of those scenarios?

Ed Harrison (13:19):

Yeah, I think that the scenario is a combination of what’s happening both on the consumer level as a result of the coronavirus and also in terms of the fiscal level and that’s where potentially the two come together. So let me put it this way, that the United States, we’ve had three waves of the coronavirus. We had the first wave, which gave us the shutdown, which was fairly global. GDP really went down hard across the globe. Everyone reopened in the spring to the summer, but the United States had a second wave of coronavirus infections. And that wave was concentrated in the South. We saw some modest falls in economic growth there, but it wasn’t a widespread national wave. And so overall, even despite the rollback and the reopening, we were able to continue to grow at really high rates.

Ed Harrison (14:21):

Now, we’re in the middle of a third wave, which started probably in late October, mid October timeframe, and the numbers are starting to rival what they were in the first wave, except it’s not as concentrated, but the numbers are high enough that we’re talking 100,000 people almost hospitalized across the United States that we’re getting to healthcare system overload in many different places. And that has precipitated a number of shutdowns, rollbacks of the economy. And that’s what’s causing a degree of growth to roll over. The more we get these shutdowns, the more you have the hospitalization causing overload of the healthcare system, the higher the probability that, that rolls over into a near recession or recession territory.

Ed Harrison (15:15):

And then when you add to that the fiscal side, then there’s an even greater risk there. On December 11th, we have the potential for a government shutdown if a new budget isn’t agreed to. We also have two other deadlines, I believe it’s this 26th for pandemic unemployment assistance to be re-upped. And then December the 31st for the eviction moratorium to be halted. So there are a number of so-called fiscal cliffs coming forward, which could have enough of a shock to the economy, both psychologically, and also in terms of just absolute dollars being spent into the private sector, that it would take us over the edge, even if the shutdowns and the consumer behavior from the wave of coronavirus didn’t do that. So Jamie Dimon, I think he’s totally right when he says there is a risk of a double dip. In fact, I would consider double dip to be my base case, given where we are right now. So when I say base, 40 to 50% probability, if not more, that we see GDP rollover into negative territory.

Stig Brodersen (16:26):

With interest rates around 0%, fiscal policy seems more important than ever in the current climate that we’re in. Janet Yellen looks like she will be the Biden administration’s Treasury Secretary, which implications does that have for us as investors?

Ed Harrison (16:42):

Yeah, I think that it means that the Fed and the Treasury can work hand in glove, as long as obviously the Congress allows the Treasury to have a free hand. It all depends obviously on what the composition of the Senate is and also how amenable the Senate is to the executive branch doing the things that they want to do. But Janet Yellen being a old hand in Washington, someone who was Vice Chairman, then later Chairman of the Federal Reserve Board, someone who knows everyone at the Fed, who has a personal relationship with Jay Powell, who’s now the Federal Reserve Chairman.

Ed Harrison (17:18):

She can work really well and effectively with the Fed. She can also work with a lot of the other people in the administration, who she knows from her time as the Fed Chair and also in Congress, because they know who she is based upon her testimony when she was a Fed person. She’s well-positioned to be effective if the United States is still an effective democracy, that is if there is not gridlock and the U.S. is not unable to get things done just purely because we’ve broken down as a democracy, then Janet Yellen would be well-placed to get those things done.

Ed Harrison (17:55):

So that bodes well. What I would say the unknown, unknown is how well Congress will receive her, how well will they allow her to do her job? And we already know the shot across the bow actually comes from the outgoing Treasury Secretary, Steven Mnuchin, who’s already tied Yellen’s hands in certain regard. And he’s also tried to tie Jay Powell’s hands. So they’re going to have to re-up what was happening in 2020. And if Congress doesn’t want them to re-up, they have a bit of a problem.

Stig Brodersen (18:29):

It was interesting you said there that the Fed and the Treasury could potentially work well together. So if we look back at the great financial crisis and you could definitely talk about a collaboration in that point in time, they did a lot of things together and did it very, very fast. Could you talk to us about, what does it look like whenever those two entities work together well, and what does it look like when they don’t?

Ed Harrison (18:52):

One way to think about it is that the Federal Reserve or the Central Bank in general is the government’s bag. That is, is that they’re doing a role that the government allows them to do. So when we talk about the Federal Reserve buying mortgage backed securities or buying treasury bonds, that’s because the government has said we’ve established the Central Bank as an independent agency, and we give them authorization to do those types of transactions. Now, in exigent circumstances, the government could say, “Wait a minute, you know what? You guys aren’t doing what we want you to do.

Ed Harrison (19:32):

We’re going to revoke your role, or we’re going to step in and do your role for you because you are actually using money that are just IOUs of the government. These are government IOUs, you’re our agent. You’re not actually an independent actor. The only reason that you’re independent is, is because it makes people understand that we’re not going to abuse our power to print money and to credit accounts. But if we wanted to, we could take that power away.” So when you think of it from that perspective, you’re thinking there’s a consolidated government balance sheet of the Central Bank and the government together with the Central Bank acting as the government’s agent in this case.

Ed Harrison (20:16):

And so if they were to act in concert with one another more so, that would be a situation which now their independence, where they’re saying, “Wait a minute, it’s important that we maintain our distance from you because people are skeptical, if we work hand in glove, that we’re not going to debase the currency. Now we’re in a crisis, so we’re going to forego that independence and we’re going to work hand in glove with you.” That’s what we did when we did quantitative easing, that’s what we did when we did Operation Twist. That’s a situation in which the Central Bank and the government are working hand in glove. A situation where they’re not, I think it’s perfectly reasonable to see in Europe, when, for instance, in Europe, before Mario Draghi said, we’ll do whatever it takes, really, they weren’t going to do whatever it takes.

Ed Harrison (21:10):

They allowed spreads to widen, Spain, Portugal, Ireland, even Italy, went over the brink. In fact, the reason that Spain, Italy, or Spain, Ireland, and Portugal received bailouts and Greece as well was because they weren’t big enough. Italy didn’t receive a bailout. And the reason that Mario Draghi intervened, isn’t just because he’s Italian, it’s because Italy is too big to fail. It’s the largest market for government bonds in Europe. There’s no way that you can have Italy in trouble in the same way without it being an existential problem for the Euro system. But that was a perfect example of the central bank and the government not working hand in glove, leading to disastrous consequences.

Preston Pysh (21:55):

Ed, talk to us about where you think we are in the credit cycle and how macro and micro investors should position themselves accordingly?

Ed Harrison (22:03):

Yeah, that’s a tricky one because I think that we’re late cycle, but there are a lot of people who are thinking that we’re early cycle. I mean, and the way to think about it is the March event, that is the correction that we had in March was that correction and then that contraction in the GDP was that the end of a cycle, or was it just a correction in the way that 1987 was a correction? Because if you think of it as a end of cycle event from a credit perspective, and then you’re off to the races, both in credit markets and equity markets, you’re starting from a incredibly high level from a price earnings ratio. You’re starting from the bottom at a level that is beyond the top of some previous cycles.

Ed Harrison (22:51):

To me, that would suggest that actually it was just a correction, it was a, what you would call a crash in the way that 1987 was a crash. And that actually the cycle will end some time later and that multiples will be lower than they are today. So that’s my sort of, how can you say? My philosophical belief, but the proof is in the pudding in terms of what’s happening, because we were just talking about the potential for a vaccine and then the rotation and devalue, and then the market being off to the races as a result of that, and potentially pent-up demand, high levels of GDP growth for at least the near term. In March, we had a huge dislocation in the markets, not just equities, but credit.

Ed Harrison (23:41):

And in credit markets, because there’s less liquidity, you had a gapping down in prices that was probably worse, a more severe liquidity crunch than you had in the equity space. And as a result of that, you had prices that were attractive in residential mortgage backed securities in particular, because there was a lot of credit support both from in the United States, the GSCs, that’s the government sponsored entities, Fannie Mae and Freddie Mac, and also from government in terms of putting money in people’s pockets. Pandemic, unemployment assistance, unemployment claims instead of 26 weeks worth, 39 weeks worth.

Ed Harrison (24:21):

So all those things were helpful in terms of making sure that instead of having 10%, in terms of forbearance, you only had three or 4% in terms of mortgage forbearance. And that market is actually a functioning market doing relatively well. So you can say then the credit event, the end of cycle credit event for residential mortgage backed securities was March. And now, once we get over this little hump with regard to the winter, the residential mortgage backed security market is in relatively good shape, but commercial mortgage backed securities, that’s a whole different ballgame. We’re talking offices, we’re talking hotels, we’re talking things that are not coming back, ever.

Ed Harrison (25:10):

Some of these hotels are going to close, some of these office buildings are never going to have full occupancy. And so the end of cycle is still in front of us. If you take that same paradigm and you switched that over into equities, then you have the exact same things that are going on. There are still some credits that are out there whose equities are trading at levels that are above zero, but they’re going to go to zero, but then there are others where there’s the rotation into value over growth that are going to really benefit over the longer term.

Ed Harrison (25:45):

So I would say that this value over growth paradigm, especially if you look at specific sectors, that’s something to look at. Is it fully priced in? Because obviously value, the price earnings ratios are lower than they are with growth. I would say that there’s going to be a convergence. The likes of Apple, the likes of Amazon, Apple trading at 40 times earnings, 45 times earnings, is that with relatively paltry growth and also a very large capitalization? Is that actually a good bet versus a chemical company or a consumer goods company? I think that I might make the translation into rotating into the cyclical, these value oriented stocks.

Stig Brodersen (26:33):

It’s no secret whenever I say that we’ve seen massive central bank asset purchase, not only in the States, but also around the world. And these purchases have been conducted through a mixture of primary and secondary market purchases, asset backed securities covered bonds and private and exchange traded funds. Now, countries have been doing this differently. The U.S. has mainly chosen the path of secondary markets. Could you please talk to us about the advantages and the disadvantages of the U.S. approach and why the U.S. had chosen that route compared to the alternative?

Ed Harrison (27:11):

I think the obvious advantage to not buying up lots of securities is price discovery, because as soon as you have someone, a large actor with unlimited balance sheet, which effectively the Fed has, they can just credit accounts and create money out of thin air intervening in the market in a large way. It’s hard to know what the market is telling you. Supposedly prices are a signal, they’re telling you whether to buy or sell, whether that market is over or undervalued, but when you have an actor like the central bank, getting into those markets, then that price signal goes away and then it distorts what people are doing with their capital.

Ed Harrison (27:52):

So capital allocation gets abused and we see that in the United States and elsewhere. So the less that you’re able to do that, the better it is. I think that there’s an emerging consensus among a lot of people, for instance, despite the massive intervention over years and years. In Japan, they’re buying ETFs in Japan, that Japanese shares are undervalued. That now’s a good time to get in and they’re doing more intervention than the Fed in certain ways. I mean, their balance sheet as a percentage of GDP is enormous.

Ed Harrison (28:24):

So I don’t know if it necessarily translates into action at one specific time. What I would say is, is that Japan is later in the cycle than we are, they’re coming out of a 30 year period, post 1989 of dealing with a debt overhang and using central bank intervention to deal with that. The United States has only been dealing with that since 2008, so that’s 12 years. So if you could say on a relative basis as a result of how long the central bank has been intervening, maybe that’s actually where the rubber hits the road.

Preston Pysh (29:01):

Ed, how in the world do we as investors position ourselves to take advantage of the debt situation in the most developed nations?

Ed Harrison (29:10):

I think, really it’s a question of what our nation is forced to do to keep that debt level from rising more. And generally speaking, what that is, is just to, going back to our earlier discussion, thinking about growth and in the absence of real growth, inflation and currency depreciation. And obviously what that really means is financial repression if you can’t get growth and financial repression is basically negative interest rates on a real basis. So I’m maybe earning 2% of my bonds, but inflation is 3% or I may be earning 1% of my bonds, but inflation is 2%. So I’m getting a negative return after inflation. Gold, silver, even Bitcoin, they look pretty good compared to that.

Ed Harrison (29:57):

Now gold, you don’t earn a return on that asset, but when real returns are negative, obviously it makes a lot of sense to get nothing and to have a store of value than to be penalized for actually holding things and getting a negative return. And we know from Europe, Denmark, Sweden, Switzerland, and the Eurozone, interest rates are negative right across the board. And so not even on a real basis, but on a fundamental basis, you’re getting a negative return. You’re guaranteed to lose money when you buy the instruments, government bonds. That’s a situation in which other stores of value will do well and potentially commodities, hard assets in general.

Stig Brodersen (30:44):

Ed, we had your colleague, Raoul Pal on our podcast and we talked to him about inflation. And one of the things he said was, “Look, when we’re talking about inflation, let’s just remember that there’s no such thing as a common metric because we each have our own index. I feel like we all have our own CPI index. Your consumption is different than my consumption.” Now, we can definitely talk about inflated asset prices. Should that be a part of say, your personal index or the common investors personal index, or is it just a different ball game if you have assets because they’re not consumed the same way as other goods are? How do you see the whole idea about money printing, inflated assets and then into that discussion about inflation? What’s the relationship there?

Ed Harrison (31:31):

That’s a hard one. I think that without getting into the technical aspects of it, immediately, my thought goes to the two price system that Hyman Minsky came up with that you have the one system, which is about goods and services, which is basically a cost plus type of model. That is, is like, it costs us this much to create these goods and services, we’re in a market up, and then we’re going to sell it on to you. Whereas in the asset model, it’s really about prospective earnings that those assets can throw off and that’s a completely different animal and you have to separate them out to a certain degree, where those two markets collide in the most difficult way is in home values because homes can be an asset or they can be a cost in terms of everyone is renting or in the United States, we have renters equivalent, it’s like, I own the home, but what’s the equivalent price that I would actually pay if I were to rent my home back to myself?

Ed Harrison (32:32):

That’s a calculation that’s made and that’s part of the CPI. And I think that that’s probably a good way to think about it in terms of separating it out that, “Okay, yes, we have the asset side of the portfolio. So when the central banks are printing all this money, some of that money goes to asset prices or actually much of it goes to asset prices, art, real estate, financial assets like gold and silver and stocks and bonds, but then there’s a completely different side of things, I’m renting the house back to myself and I’m buying up goods and services that I need to live on and maintain my family.” And those two only intersect in that little narrow space in terms of owner’s equivalent rent.

Stig Brodersen (33:20):

So let’s talk more about money printing. The audience might be sitting out there thinking, “Oh my God, they talk about this money printing every single weekend, can’t they come up with something new?” But it is just so interesting. So guys, please forgive us. Ed and I are just geeking it out here. The moment that the central bank prints money, it doesn’t create or destroy any value and that might sound a bit surprising. We have Dow Jones here, 30,000 and it might just all sound a little confusing because we all heard that you print money and then asset prices just skyrocket, right?

Stig Brodersen (33:54):

But the money printing is technically a loan between two entities and they could be the Fed and the government. It doesn’t have to be, but it could be those two entities. And that creates an asset and a liability. And so they even each other out, so there’s no wealth destruction or creation as such, but using the money printing here in 2020 as an example, do you think that the Fed has effectively created or destroyed wealth long-term for the economy? In other words, what’s the first order and then second order derivative of what’s happening right now?

Ed Harrison (34:25):

So I think that it’s about asset price signal distortion. The Austrians, the Austrian economics is a good example of this. If you think about Keynesian economics, a lot of times we talk about aggregates, aggregate demand is a big thing. In Austrian economics, people talk about time value of money, that is, is, is that things that have value over the longer term when interest rates are low and when central banks are buying of assets, those things tend to be relatively more richly valued because money is cheaper. And as a result, the time value of money is lower. That means I can hold onto this money for a longer period of time and when I get my return 10 years down the line, it’s almost as good as a return five years down the line.

Ed Harrison (35:13):

Whereas when money is more expensive, getting my money 10 years down the line isn’t anywhere close to as good as getting my money five years down the line. So when we think about it mechanically in terms of what the central bank does, the central bank, as you said, it creates an asset and liability. What am I going to do with that $1 billion? Well, I’m going to go and buy an asset. What asset can I buy? I’ll buy a financial asset, mortgage backed security, I’ll buy a government bond. Once they buy that government bond, usually from a bank, that bank then transforms from having had an asset, which was a government bond or a mortgage backed security to having reserves. And so those reserves either sit idle at the central bank or the bank goes and utilizes it and buys something else.

Ed Harrison (36:02):

That’s where the asset price inflation happens, that’s where the distortion happens, because that bank doesn’t want to sit around. Just imagine that I’m a bank and let’s say I have a balance sheet of 100 billion dollars. And over time, a billion here, a billion there, the central bank buys off my assets. Those assets let’s say they were spinning off 50 basis points of 0.5% of interest to me. Now, I have reserves of 100 billion dollars just sitting there doing nothing. What am I going to do? Well, I’m going to use that 100 billion dollars, I’m going to buy other assets so that I can get a return on my money. The distortion goes mechanically from the central bank buying assets off of the banks, and then the banks moving into next best markets from where they were originally. So going from mortgage backed securities and government bonds to say, corporate bonds or junk bonds or equities, and that builds up the prices in those next markets as well.

Preston Pysh (37:07):

Ed, we see China and the U.S. continue to decouple. This is the classic example of rival powers. Just to mention a few examples, the U.S. has made it more complicated for the Chinese companies to be listed in the U.S. and China has invested heavily in eventually being self-sufficient with energy and semiconductors. How can I as an investor take advantage of this increasing decoupling?

Ed Harrison (37:30):

It’s a good question. The way that I would answer the question is that it seems to me the obvious outgrowth of the decoupling over time is that China’s going to form its own ecosystem of countries that are around it so that those are reliable trade patterns where the United States used to be a trade pattern. People talked about Chimerica, that’s no longer so that they maybe have a more regionally based trade relationship with other countries and those countries, they can trade in their own currencies. The upshot of that is, is that the U.S. dollar comes less important for those countries and probably that’s in Asia in particular.

Ed Harrison (38:21):

So to the degree that the U.S. dollar is less important from a capital account perspective, that would suggest that the United States capital account surplus that people because they want to get dollars, will become less than it was before, which means the current account deficit will become less as well. Interestingly, I would imagine that that means a weaker U.S. dollar over time and a stronger, you want stronger Asian currencies that are tied to the Yuan in that trade relationship. And therefore, to the degree that you still have strong growth in those markets, you also therefore have stronger equity valuations, whether you’re valuing them domestically or in foreign currency.

Ed Harrison (39:09):

You get the foreign currency appreciation if you’re not doing it domestically. One thing to think about too, I think in terms of these currencies is that they also, a lot of times have had U.S. dollar liabilities. If they’re creating trade in bilateral relationships and they don’t need the U.S. dollars, maybe they don’t need U.S dollar liabilities as well. So that’s also a locus of problems that they no longer have. If you think about the 1998 Asian financial crisis, maybe that crisis doesn’t happen because that was actually as much a dollar problem as it was a debt problem, a liquidity crisis as much as a solvency crisis. So to me, that says that emerging Asia, ex China could be attractive in that relationship. So that’s how I would play that as a long-term play.

Stig Brodersen (40:03):

These tensions there are between the U.S. and China right now and the continued decoupling that you were hinting on that beforehand, where does that leave Europe? Because I can’t help but think about, there’s this famous quote by this European politician who said that whenever goods cross borders, soldiers do not. In a way, we feel we should protect ourselves, but it’s also important that we keep working together and so you have the U.S. as a superpower and China, arguably a rising superpower, if not already and then you have Europe in the middle, like the old world. What’s happening with Europe?

Ed Harrison (40:41):

They’ll have to choose which side they’re going to go on. I mean, if you think about it, you can divvy up the world into the North America, Europe, Asia, you can talk about Africa, South America, and then maybe you have a few floaters like Russia, Turkey, there’s Australia and New Zealand, where are they going to attach themselves over time? Australia, they’ve attached themselves to the Chinese from a trade perspective, much more so than say, 20, 25 years ago. If there’s a decoupling with the United States, then I think Australia will end up choosing the U.S. over China and that’s going to be a painful process to decouple themselves from that relationship.

Ed Harrison (41:21):

Europe, they have the same problem. Where do they choose their battles? I think that they’re going to be much more aligned with the U.S. just from a pure economic and a social perspective, a governance perspective. There’s a natural synergy between the West, as let’s say, embodied by Germany. Think of Germany as the equivalent of the United States and the likes of say Poland, or even Bulgaria, Romania, Hungary, as similar to Mexico or to Central America for the United States. There’s a potential regional deepening there that you could have where there’s a symbiotic relationship. And I think that if you can overcome the political barriers, you can get there and that’s the more natural fit for Europe over time.

Stig Brodersen (42:11):

I think that’s also a nice segue of saying as most of the listeners who are following the show, probably know by now we are avid readers of financial history here on The Investor’s Podcast and we like to look back hundreds, if not thousands of years. And it’s especially interesting to learn about the people’s mindset at a specific time and how everyone always thinks that we are now in an unprecedented time facing challenges that we’ve just never seen before. And it’s often not the case. And we have faced almost exactly the same problems before, if only we had a full understanding of history. But from time to time, we are indeed in a completely new territory with no best practices from the past that we can learn from. So with that being said, do you see anything in the macro environment that is truly unprecedented at the moment, or is history repeating itself right now?

Ed Harrison (43:05):

It’s hard to say with regard to Bigpoint and cryptocurrency given the fact that we’ve seen different currency regimes and whether or not you could say that there is an equivalent. I don’t think of digital currencies as digital gold necessarily, I think that they’re a totally different regime. And so the real question is, is given the fact that these are new, are they equivalent to gold and silver, and therefore can become stores of value separate and apart from fiat currencies, currencies that are issued by governments, currencies that are used as media of exchange in a normal day to day, or are they not going to be like the gold and silver were?

Ed Harrison (43:54):

Gold and silver were money before fiat currencies and before government money was money. In fact, government money in the old days was made out of silver coins. You clipped your coins, you tried to make the edges of them less, so you were giving people less gold. But the reverse is happening with Bitcoin, Bitcoin is coming after the fact, you already have the fiat currencies and now it’s Upstart that is a challenger to government money. Is it going to work? To me, that’s the most unprecedented story that’s out there because if it does work, potentially the numbers that we’re seeing on Bitcoin today, 20,000, are nothing compared to what you could see going forward. But then at the same time, if it doesn’t work, maybe those numbers are incredibly inflated and the whole thing just dissipates very quickly. So to me, that’s a very binary outcome. That’s to me where a lot of money can be made or lost.

Stig Brodersen (44:54):

I didn’t expect that you would say anything with Bitcoin, when I asked this question. I thought you would say something about the bond market repeating itself or not repeating itself. So I know this is a very leading question, but do you see anything unprecedented in the bond market? Is it business as usual? And if yes, what led back to where we had a similar type of market?

Ed Harrison (45:15):

It’s business as usual, the markets are showing incredibly tight spreads. And when spreads get as tight as they are, discrimination of risk becomes relatively poor. And that means that at some point you get a gapping out of spreads that’s uneven. Maybe the entire market gaps out when you have an event that crystallizes industries across companies, but some companies, which you should have discriminated against are going to gap out a lot more and that’s where you’re going to get crushed. The interesting bit is, is that, I’ve spoken to a lot of credit investors recently and they’ve said to me that this is where the money gets made.

Ed Harrison (45:55):

You can clip your coupons over the course of the cycle, but the alpha is returned during the downturns because that’s when companies and bonds, they get 10 cents on the dollar or 12 cents on the dollar, you don’t get your money back. That’s when the defaults happen. That’s when your ability to actually do credit analysis and judge credit risk appropriately comes into play. So to me, this is an age old problem. We’re at a point in the cycle where I think that there’s a lack of differentiation and that’s going to come due, the bill is coming.

Stig Brodersen (46:31):

Well, Ed, I can only say once again, it’s been absolutely amazing having you on the show. I mean, we always learn so much whenever we have you here. So first of all, thank you for that and we would definitely like to give you the opportunity to tell the audience more about where they can learn about Credit Writedowns, Real Vision, and more about you.

Ed Harrison (46:54):

First, let me say thank you as well. You asked the best questions. It takes me to the edge of my wheelhouse, if you will. I’m looking outside the wheelhouse, but still within it, kudos to you on being able to do that. In terms of where people can find me, Real Vision, definitely, first and foremost, they can see me doing lots of interviews on that, video interviews, but also, Credit Writedowns, which is pro.creditwritedowns.com, that’s my newsletter. Maybe once a month, something like that, you can get a free article, but usually everything’s behind the paywall.

Stig Brodersen (47:31):

Fantastic. We’ll definitely make sure to link to all of that. Thank you so much for your time. We already look forward to bringing you on back again, 2021.

Ed Harrison (47:40):

Yeah, I’m looking forward to it as well. Have a safe and happy end of the year and a Happy New Year as well.

Stig Brodersen (47:48):

All right, guys, that was all that Preston and I had for this week’s episode of The Investor’s Podcast. Trey and I will be back next weekend.

Outro (47:55):

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