Episode 4 of The End Game saw Jim Grant join Bill and Grant for a hugely enjoyable walk down memory lane in search of clues to our likely future.
Jim’s wealth of historical knowledge proved enormously helpful in picking apart lessons from the 1960s, 1970s and 1980s – times when the market conditions were nothing like those in which we find ourselves today.
How did we get here and what can we learn about the Fed’s likely response to inflation going forward? In his own, inimitable style, Jim does a wonderful job of chronicling the past and laying out a potential roadmap for the future.
Grant Williams:
Before we get going, here’s the bit where I remind you that nothing we discuss during The End Game should be considered as investment advice. This conversation is for informational and hopefully entertainment purposes only. So while we hope you find it both informative and entertaining, please do your own research or speak to a financial advisor before putting a dime of your money into these crazy markets. And now, on with the show.
Grant Williams:
Welcome everybody to Episode four of The End Game. We have got our latest guest joining us shortly, someone, who will need no introduction, but we’ll give him one anyway. But, with me on the journey, as always, my co-conspirator Bill Fleckenstein. Bill, are you there?
Bill Fleckenstein:
I am here and I’m anxious to get into it and talk to my good friend Jim Grant about some big-brained topics on what the future might look like.
Grant Williams:
Yes, we will do this. Sure. Just before we get started, Bill, the response from people to our last conversation with Mike Green has been just fantastic. I mean, as a bookend to the conversation with James Aitken the time before, it was just fantastic.
Bill Fleckenstein:
I was pretty impressed to see the things that people noted and I’m glad that it would appear that our idea of talking to people that have some interesting thoughts about these complicated subjects is proving useful and I think the mind-bender that Mike Green has unearthed about passive investing, I think, threw everyone through a loop, as it did me, and I think you as well, once we first heard about it.
Bill Fleckenstein:
But that’s the whole point of this stuff, it’s to see if we can figure out some things that might be useful for people to contemplate as they try to figure out how to navigate the financial craziness that we’re in the midst of?
Grant Williams:
Yeah. Absolutely well said. Navigating our financial future is something that we’re trying to figure out and our guest today has done a phenomenal job, probably better than anybody, of chronicling the financial past, his knowledge of history is unparalleled and his ability to distill those trends and look into the future and offer potential outcomes and potential scenarios is something that I’ve found incredibly valuable over the years.
Grant Williams:
So, without any further ado, let’s welcome our mutual friend Jim Grant to the podcast. So, Jim, the matter at hand is the End Game of sorts. Bill and I are in search of various people who might be able to give us some insight into what it might look like and you, as I said, are one of the people we figured would be a great sounding board for either our ideas or some thoughts of your own.
Jim Grant:
Well, I will do my best. We have three hours in this thing. We can come up with something.
Grant Williams:
Yeah. I’m sure we can. Bill, I think we lost Bill again. I think we might have to kick him out and get him to start again.
Bill Fleckenstein:
All right, sorry about that. Jesus.
Jim Grant:
Isn’t this funny? The guy with the technical problems turns out to be the programmer.
Bill Fleckenstein:
The former computer programmer. Okay, smart guy. Let me start you off with a question about your most recent lead essay in the last issue, because I thought it’s an interesting juxtaposition of monetary conditions coming from an unusual source. You pointed out that in the late ‘60s, coins became scarce because of their intrinsic value, people were melting them down, and now coins are scarce, seemingly because they’re not worth anything. Would you like to comment on the transition between those two short periods of time?
Jim Grant:
Yeah, in the Early ‘60s, coinage was silver. In fact, if you are of a certain age, you grew up talking about silver as a shorthand for change and the intrinsic value of a coin was, of course, related to the market price of silver. Silver was a dollar an ounce in the early ‘60s and I think the breakeven on one of the coins, was, I think, $1.29 for a quarter, just for argument’s sake that way. As the price of silver rose, as the 60s wore on, you were presented with a primitive arbitrage opportunity involving a melting pot.
Jim Grant:
People began to collect these coins and melt them for the silver and the expression of this opportunity took all sorts of different forms. Las Vegas slot operators needed coins by the wholesale and job lot and they had to pay up for it, they had to pay a premium of $4,000 worth or $10,000 worth of coins. When coins disappeared and the vending machine operators began to complain and the Chase Manhattan Bank put out a sign saying, “If you would give us your change, we’ll give you in return, some nice crisp, fresh dollar bills of which we have an unlimited quantity”
Jim Grant:
That was the symbolic expression of a coin shortage, that in fact, had a deep monetary connotation. So, that was the early ‘60s, and the ‘60s wore on, it turns out that silver went way above 1.29 and the coin used to… In 1965, LBJ, Lyndon Baines Johnson, then president, signed the bill, de-monetizing silver and the coins henceforth became slugs. That was ‘65 and it was six years later that the United States suspended convertibility of the dollar at the fixed rate of $35 to the ounce of gold.
Jim Grant:
So, the silver hoarders in that time, seemed to have an eye on monetary conditions with the bond market, for example, that not interest rates were stable throughout this period, disappearing silver. So, that was then. And fast forward to the present day. What can we say about monetary conditions today? Well, in one respect, we are looking at net progress. Now when people can walk into a store, even for very small denominations, and stick a very handy plastic card in the nice applicator, and lo and behold, transactions finish, no fuss, no muss.
Jim Grant:
So that count as a stride forward in human technology and progress. No, that’s a good thing. But the coinage, nonetheless, still serves a purpose and it has gone missing. Why is that? Because commerce itself has gone missing, in good part, owing to the virus and in particular to the governance lockdown. So what does this say about monetary affairs? Well, it says… I think it says, it’s a marker, it’s a marker of the government’s increasing presence, one might almost say omnipresence and our monetary and financial affairs.
Jim Grant:
So the government has taken upon itself to shutter commerce and good part coins disappear, and the coins that have disappeared are mere slugs, mere symbols, just as the dollar bill is now a mere symbol. So it’s an interesting contrast and one could make the case is both the mark of progress on the one hand and the mark of deep retrogression on the other.
Bill Fleckenstein:
Well, obviously, part of the reason for the wisdom behind doing that then was because as you pointed out, the price of the underlying precious metals was moving up. It appears, as though, because people were beginning to anticipate a higher rate of inflation. Now, if we fast forward to today, obviously, they’ve gone missing for a slightly different reason. It doesn’t change the fact that they’re virtually worthless. But is there some way to torture the facts, to suggest that that’s a precursor of more inflation or people’s expectations of more inflation? What do you think?
Jim Grant:
No, I think the disappearance of the coinage now is simply a matter of that stores don’t recycle them as they did. And for one, I’m exactly on the same page as the chairman of the Federal Reserve Board, Jay Powell, my friend and I, see eye to eye, this is the first time they’ll see this-
Grant Williams:
This is a soundbite for the ages here.
Bill Fleckenstein:
Yeah.
Jim Grant:
Jay is exactly correct. Exactly correct. Coins have gone missing because of the lockdown. Okay, that’s the last you’ll hear that one.
Grant Williams:
Jim, let me ask you. There is something you said when you talked about, just the man in the street arbitraging this difference between silver and the silver price, which humans and market participants have done forever, whenever there is an arbitrage it gets arbitraged away. What do you make of general conditions now? And we’re in this point where, for example, the Hertz madness, which again, you chronicled so brilliantly in the Grant’s Interest Rate Observer.
Grant Williams:
That kind of madness, where you see things happening, which are patently ludicrous and provide an enormous arbitrage opportunity, one would think. But the professionals that are able and willing to take the other side of those ARBs, seem to be crowded out now by a whole bunch of irrational actors. What do you make of that? Because I find it extraordinary.
Jim Grant:
Well, Grant, it’s a wonderful observation and a great question. You have to begin to ask, so, what’s irrational? And is it irrational to crowd into the stock market and chase momentum when the rate of growth and broad money supply is the highest in any peacetime period in modern American history. As of last time we looked at it, not so long ago, that M3 is pieced together by our friends at Shadow Stats was running at a rate in excess of 20% year over year, now, you don’t see that.
Jim Grant:
Ordinarily, you don’t see the Fed’s balance sheet expanding as it had been doing little late in the spring, at rates in excess of 700% per annum. So, people have been buying stocks and they’ve been buying stocks in the knowledge that the Federal Reserve has been interposing itself between credit risk and the price of fixed income securities affected by investment grade securities, has dabbled in junk, of course, buying mortgages, it has bought mortgages and treasuries by the job lot.
Jim Grant:
So interest rates are under the thumb of the Federales and money supply is running as rapidly as it has done in anyone’s lifetime now. And, so what do you do? So one could make the argument that this action in the securities markets is not so irrational, although the form it takes from time to time is a head scratcher if you’re one of those people buying the equity of a bankrupt company with the debt trading at a yield that is well in excess of 30% and 40%.
Jim Grant:
You do wonder, what you’re thinking about, as you consummate the transaction. Perhaps you’re thinking that the guy at Barstool Sports is really smart. There is a strain of randomness and devil may care and joie de vivre on the part of these quarantined people there’s a little action, that’s not irrational, what a little fun out of life when you can’t go outside for breath?
Grant Williams:
Yeah.
Jim Grant:
But I think that the Fed is fond of talking about market function as a reason or a pretext for these massive interventions, but then it seems to me that we have much less functional market functioning. Now, the FED is breathing down all of our necks more than we had before.
Bill Fleckenstein:
Let me ask you this, Jim, you brought up an interesting point about the money supply really moving at a fairly rapid pace for the first time in quite a long time. I have a smart friend who’s a bond guy, who I argue with about inflation from time to time, and he makes the point that the money supply growth doesn’t count because so much of it is PPP loans and he believes that the distinction between a PPP loan and an ‘otherwise productive loan’ is a very big deal.
Bill Fleckenstein:
I, myself, can’t really, I mean, I can understand it, but I don’t really believe it. Have you thought about that? And do you think that makes a big difference, what the money actually goes for?
Jim Grant:
Money is fungible, and it doesn’t matter whether it’s labelled as a PPP loan or as a working capital loan. I think there is something to the argument that some of this money growth will prove to be temporary, because, for example, companies took out huge cautionary loans in March and April to make sure they had enough money to roll over debt and debt markets were not functioning. I think that this positive torrent of monetary expansion will subside.
Jim Grant:
But what is different now about the prior 10 years in which, despite the FED’s exertion, as their balance sheet was growing, as it had not grown previously, it seemed as if this were an inflationary signal. Certainly, I was on that view for too long. What’s different now is that the FEDs impulses have been translated into very rapid growth in transaction balances. Now, that was not the case for most of the period from 2010 or 2011, up until 2019.
Jim Grant:
So we, as usual, know more about this in five years. I am much less inclined to be dogmatic about that. I might have been when I was 20 years younger, 20 years ago I was probably about 80 years old, I guess. Then I was of the view that somehow the future had been revealed to me alone and so many of these questions made me slightly more, if not wiser, certainly humbler about the future.
Jim Grant:
I think that if you’re looking for a possible inflation setup, I think that was perhaps what… Bill what you were driving out this question here is the way I see things now with respect for the likelihood of new inflation. On the negative side, I see the terrific undertow, a deflationary undertow, certainly a tendency of debt to be a force for deflation. Why? Because encumbered or leveraged companies have to generate revenue to service fixed charges.
Jim Grant:
So to generate revenue you produce, and to produce you make more of what you’re making and that sacrifices margins, simply to bring in the top line. That’s one force on the deflation side and there’re others like that as well. But on the contrary side, I see a much stronger case, and that case would include, for one thing, the expression of sentiment, not merely in words, but in deeds. Look at them, I’ve lost track of a current tally of 16 and some income securities worldwide are yielding less than nothing in nominal terms and it had been 10 or 12 trillion.
Jim Grant:
But think about it, the people in charge of $10 trillion worth of bonds are satisfied to accept less than nothing with the assurance of getting something from a government that is issuing currency it intends to debase. So that’s one citing. A second citing is something that I just got from friends at Leigh Goerhring and Adam Rozencwajg.
Jim Grant:
They’ve a commodity related investment firm and they have recreated the Goldman Sachs Commodity Index, they have recreated it going backwards and it’s reverse-engineered from the year 1900 and they’ve compared that against the Dow. They figured that the reverse-engineering is more or less correct because they’ve checked it against the current GSCI.
Jim Grant:
All right. So then let’s stipulate the stats are okay. And what they find, is that in relation to financial assets, as expressed in the Dow Jones Industrial Average, commodities are selling at the lowest point in 120 years. That is another point of sentiment not merely in words, but also in deeds. So the world has come to believe in the efficacy of the pure paper monetary standard, hence, the popularity of bonds at these yields. The world has come to trust the judgment and the deeds of the people like Ben S. Bernanke PhD and the 700 odd PhDs.
Jim Grant:
Everyone has, I think, collectively bought into the efficacy of macroeconomics, which I think is actually not very efficacious. I think macroeconomics is rather an empty bag. But people have bought into the monetary regime, they’ve bought into the notion that interest rates only declined since 1981, that’s upwards of 40 years. How’s that for muscle memory? So, I think that things are set up for surprise and so all if you want to know, naturally, is what are you being paid to bet against the grain, against the received wisdom.
Jim Grant:
Well, I don’t know. There might be some cheap miners, Bill and Grant, I think you know more about these valuations than I do. My friends at Goehring Rozencwajg contend the commodity stocks, generally, are as depressed against financial assets as the commodity indices themselves are. So, however this turns out, at least, the setup to me, the pro inflation setup, is appealing and interesting and the odds appear welcoming and that’s all you can ask for when you can’t know the future.
Grant Williams:
Jim, let me ask you, I would add that that negative-yielding total amount in the world, extraordinarily went from, I think 15 trillion down to just below 8 in March, but it’s back up at 14 again. [crosstalk 00:19:40]
Jim Grant:
I didn’t know.
Grant Williams:
Yeah. It’s remarkable.
Bill Fleckenstein:
As an aside, I saw a squib from someone in the last two days, that if you add up all the bonds that yield between 0% and 1%, it sums to 100 trillion.
Grant Williams:
Right.
Bill Fleckenstein:
I don’t know if that could be correct or not. But Jim, you know more about those big numbers than I do, but that would be pretty powerful if true.
Jim Grant:
Yeah. I think that’s wholly unreasonable and reasonable.
Grant Williams:
At the same time. Yeah. So Jim-
Jim Grant:
Impossible but believable.
Grant Williams:
Right. Given your 100 years on the planet, that would mean that you, unlike myself, certainly, and Bill probably has a better recollection, but the turn back in the end of the 70s, towards that inflationary cycle of the 80s, perhaps you can paint a picture for us of how that looked at the time, and your recollections of what that term looked like. Because it does feel like, as you point out, we’re at that extreme again, where a turn, one would think, becomes more likely, if not probable, and certainly more possible. Can you sketch what you saw then and maybe the signs that you would look for?
Jim Grant:
Yeah. Well, I’ll do my best. I think the… Let’s go back to 1960 and we’ll build up to 1981. September 30th of 1981 was the day the long bond peaked intraday, yield at 15%, and the whole drama began really at around 1960. And what is so interesting, the first five years of the decades of the 60s, was the stillness and the self-complacency that that stillness encouraged among people who are guiding our monetary destinies way back then.
Jim Grant:
The rate of inflation in those five or six years inclusive 60 to 65, great inflation. I think Inflation never got above 2% and frequently was below 1%. And all this time the long-dated treasury was priced at approximately 4%. So, about 3% points of real yield. But those five years of the first half of the 60s were a time of coordinated interest rate, the historian Sidney Homer characterized that block of time as the least volatile in history up until that time., that was still, he wrote the book in ‘77, I guess.
Jim Grant:
So, that was a setup. So what did people take away from that stillness and from the utter lack of volatility? Well, they took away from the fact that the Keynesian method of managing our affairs had finally found the Philosopher’s Stone. The unemployment rate was very low, the inflation rate was very low, interest rates were stable, the economy was growing like gangbusters. What was not wonderful?
Jim Grant:
All right. So the backdrop to this was a little bit less stable and slightly more worrisome and that is United States than had this Bretton Woods system whereby it stood to exchange dollar bills at foreign banks and central banks had collected. The United States stood to exchange those green pieces of paper for gold at a ratio of $35 to one ounce. That was the deal. That was the Bretton Woods deal.
Jim Grant:
The United States had been losing gold from the late 50s. And the Vietnam War began to hot up in 1965/1966 and we lost more because war costs money. So the draw on our available gold, they called it free gold, or on gold available to satisfy foreign claims that dwindled in relation to those claims. And the FED responded with Operation Twist, it was an attempt to manipulate the yield curve to encourage dollars to flow back to this country, to raise short term interest rates in relation to long.
Jim Grant:
So it was a decade first of complacency then of concern and finally, as you get to the early 1970s, of urgency, and that explains why Nixon felt he had to suspend convertibility, no, we should call that a default. When the United States defaulted on August 15th 1971, and the same day Nixon defaulted, he also introduced wage and price controls.
Jim Grant:
The inflation dogs were then well and truly out of the kennel. And not in a straight line, of course, the inflation rates subsided. I remember Bob Blyberg my mentor at Barron’s wrote an editorial called a Whiff of Deflation. This was when the government was commanding everyone to wear whip inflation now buttons during the brief Gerald Ford presidency. But in comes Jimmy Carter and lots of spending, a very loose FED, and before you know, the rate of inflation was not 4% but 5, 6, 7, 8, 9 and at length, double digits, and of course there was this Arab oil embargo as well. Shortages of everything, you couldn’t find anything you wanted to buy.
Jim Grant:
Great puzzlement in the precedent. Why? There were these shortages. So muscle memory takes its own course because things have been turning inflationary. Keep going to the late 70s from upwards of a dozen years. And bond prices, what we knew about them, was they went down, that was the Dogma. They have been going down since the spring of 1946. Not in a straight line, but persistently.
Jim Grant:
So the yields have begun to go down to a level of two and a quarter. I’m sorry go up on prices down. Two and a quarter was the low end in 1946 and before you know it, in the 60s there were the sexy sixes and then the sevens and eights, nines and an issue of treasury’s call for DC 10s. And morbidly, or ghoulishly called because that coincided with the crash of a McDonnell Douglas DC 10 airliner.
Jim Grant:
At length 10 turns into 11… by this time, what you really knew was, there was no hope for the bond market. Nevermind that Ronald Reagan had broken the air traffic controllers, never mind that Ronald Reagan was president, never mind that the deregulation was the way forward, an idea shared both by Jimmy Carter and Ronald Reagan. Never mind that commodity prices had gotten so high that it seems to me, they weren’t much of a bargain, in fact, they seemed a little bit excessive.
Jim Grant:
But still, you knew about interest rates, you knew what they did, they went up. And for no reason that was announced beforehand, nobody issued a press release. The fall of 1981 proved to be it, that the forces of reversal were in place. 15% was a terrifically depressing rate of interest to pay on the Treasury obligation, depressingly for anyone who had to bear that cost, certainly. Mortgage rates in excess of 15% were not encouraging home formation.
Jim Grant:
And in retrospect, one could see that something had changed. Something had indeed changed for the gold market, it peaked at 800 and worked, to see how ounce in early 1980. But even that was not a straight line because fast forward to 1984, the inflation rate was now back from 10% to 4%. But lo and behold the long bond, suddenly, in the spring of ‘84, yielded at 14%. 10% points of real yield available for anyone who would avail himself or herself of the securities on offer, and you could buy zero coupon treasuries that would internally compound at rates in excess of 13%.
Jim Grant:
Equity returns no equity risk, who wants them? I think Bill Fleckenstein was the only buyer. Bill, was 12. And he bought some, but very few people availed themselves because we knew what interest rates did, went up, the bond price went down. Well, I’ve been talking for 25 minutes. So this narrative from the early 60s to the mid 80s… I’ve met it to describe, the halting progress in both directions. At first, the inflation thing seems impossible after all… How can inflation come out of no inflation? That was the view in the mid 60s. But it did.
Grant Williams:
Right.
Jim Grant:
And then in the early 80s, how can little inflation come out of loss? Impossible. Well, that too proved, not only possible, but it proved that it happened. So we can all apply this in our own ways. I must say if this recital of facts and narrative seems fluid, because I have been inflicting it on the readers of Grants for longer than just now I have to remember, and no one can look it up because it’s too embarrassing.
Jim Grant:
So I’m not saying it’s reversible certainly and Grant you can pose the question that way, but my goodness, it does seem as if we’re overdue for some interruption, and this did certainty of what interest rates do and what other assets do.
Bill Fleckenstein:
Well, what your vignette there made quite clear, and brought back memories for me, was how certain people were about the impossibility of both inflation and then disinflation. And you could juxtapose that to now, and there’s a certain, I would say, certainty that we can’t have any inflation, even though, what you have described, was this more, there are lots of reasons to think that they’ve created the strong preconditions for just that.
Bill Fleckenstein:
So, one of the things I’d like to ask you, going back to your prior point, was you mentioned how we didn’t really get the FED to the banking system transmission mechanism, really going in the say 2011 to 2020 period and perhaps that’s what kept inflation more in check to the degree that it was, even if we believe the data, but during that period, we didn’t really have an increase in deficit spending, other than the first three or four years of the Obama administration.
Bill Fleckenstein:
Relative to now, now we’ve got, maybe the transmission mechanism ignited, as you noted, and now we’ve got massive deficit spending everywhere. Do you think that adds to the argument? Or is that just meh? Just another fact? Or is that a powerful fact?
Jim Grant:
Yeah. I think it does. And what is so extraordinary to anyone who had a little bit of experience watching, not only events but also the way that investors frame events, it was so interesting, now is the utter disbelief that anything like deficit spending could prove to be disadvantageous. I mean, in 1979 ‘80 ‘81, there’s a positive fetish about the federal budget and deficit spending.
Jim Grant:
And the spending then, was, of course, nothing compared to what we have now, but people focused on that. Do you remember the Reagan deficits? People were all over Reagan for the ruination of the federal finances of the public credit. That was trace.
Bill Fleckenstein:
Don’t you remember how they excoriated Stockman for trying to tell the truth?
Jim Grant:
Yes. Yeah. And then what happened was, of course, that the public debt doubled, or tripled rather, and interest rates halved. And It was such a slap in the face to anyone who would care about the deficit then. And I think a lot of that attitude has continued after all and currently is you look at, so what is so inflationary about, I’ll ask you again? The 10-year yields of 61 basis ounces would have yields this moment. And why can’t we just keep on doing this?
Jim Grant:
This explains the sudden popularity of the so-called modern monetary theory. It works. I mean, what’s the harm? And the people who would contend that there is harm or can make all the arguments they want to a point of view, but finally, they are reduced to saying “Just wait”.
Grant Williams:
Yeah.
Jim Grant:
Many people find it unpersuasive.
Grant Williams:
As you are walking us through that period, there’s so many bells going off in my head about conditions which are extremely similar and yet diametrically opposed. To hear someone like you with that grasp of the timeline run us through it, it’s almost a mirror image. And when you talked about expectations, I keep thinking about this idea of scarcity when we had this inflation scare in the 70s, the oil shock, and as you pointed out, the fact that people were struggling to get hold of things.
Grant Williams:
We’ve seen the pandemic now and my friend Pippa Malmgren was talking about, how in London, when the shelves were devoid of bread, a couple of months ago, people would willingly expect to pay more for such luxuries, as items as bread. And It’s the expectations component that seems so important. Are you seeing stirrings of expectations? Or, again, is that something that is managing somehow to remain subdued?
Jim Grant:
Yes. Last weekend, there was a newspaper headline, page one headline, in a tabloid called NewsDay. NewsDay is a paper of Long Island. And the page-one headline was, The prices are going up on Long Island. This was presented as rather a scandal and the consumer reporter who handles instances of being shortchanged in stores and roofing companies ripping you off for overcharging, that guy was covering this. It’s small consumer exploitation.
Jim Grant:
But as you read the story, it wasn’t a very deep story, but the story said, that because entrepreneurs, and they were talking mainly about neighborhood, their restaurants and bars and dry cleaners, because they were doing much less volume, they had to compensate by charging more. And some people found that reasonable, in any case, it was what was happening. And that seems to me a commonsensical thing.
Jim Grant:
If you are running a business and you have half of the foot traffic, what do you do? You try to get compensated and people just, as you say, Grant, and I think I’ve learned to expect some of this and they may too have judged it to be reasonable.
Bill Fleckenstein:
Well, so you’re touching on the inflation psychology component. We can call it expectations, but it’s the same sort of thing. It may be a necessary prerequisite that people somehow become a little preconditioned. Obviously, the labour unions, the strength of them, helped exacerbate the inflation of the 70s and we don’t really have that dynamic work, but maybe what people have experienced with the virus, and so in the disruptions caused by the virus with shortages and maybe buying extra stuff, just in case as opposed to just in time, maybe that psychological willingness, perhaps, to recognize the fact that prices may go up, may in fact, be part of what’s needed to change the inflation psychology and expectations.
Jim Grant:
Yeah, I agree. You and I Bill, have both enjoyed a phrase from yesteryear. And one of my biographical subjects said, Bernard Baruch, a speculator and political figure from the early 20th century, quoted a mentor of his at Wall Street, Bernard Baruch came up as a broker that have a one man hedge fund.
Jim Grant:
And his mentor would use a phrase, The continuity of bullish thought or the continuity of bearish thought. And what happens when a trend change was the continuity, that’s called bullish, the continuity of bullish thought was broken. And it sounds a little bit airy and insubstantial, except it speaks to a very important thing, which is the mindset and expectations of investors. I don’t think there was anything in the physics of the debt market that caused interest rates, bond yields, to go from 10% to 15%.
Jim Grant:
I think that was, to me, purely a matter of surrender and of speculative give up and of a trend that is just playing itself out. And maybe that will prove to be the case with inflation as well. I don’t think inflation is always in everywhere a monetary phenomenon. I think it is a tautology, always have its remote basis in excess of currency. I think it’s timely, it’s a moral phenomenon, there is something for nothing, is the nature of inflation.
Jim Grant:
I think it is also a phenomenon of confidence, confidence in the Central Bank and the nature of the currency that the central bank producer and distributes. We’re now, somehow we’ve all come, accepting people on this call, but many of us have come to accept that the central bankers truly know what they are doing, they are in charge of events. Well nothing like that was in the air in the late 1970s when G. William Miller was running the Fed before Paul Volcker stepped in.
Jim Grant:
The FED was rather the laughingstock, the bond market didn’t take it seriously. That explains why yields went up and up and up, and why the inflation rate went up. When people don’t trust money, they don’t want to hold it. Simple as that. So, why wouldn’t you want to hold dollars? Not because something is getting… they are not appreciating in value but you can go out and buy an extra tube of toothpaste, because that item of merchandise is going up next week. That’s inflationary transaction.
Jim Grant:
It is an example of an inflationary mindset. It was certainly prevalent for many years and it’s possible that it’s coming back again, but certainly not, if it is coming back, nothing to say it is coming back soon. But the timing I will leave to you.
Bill Fleckenstein:
Speaking of the timing, that leads to one of the topics of our ‘show here,’ that being the End Game. I’d like to put this to you. I mean, obviously, something will end the insanity of printing money and something for nothing and all of that. My shorthand version has always been, somehow the central bank loses the bond market, now, exactly what loses the bond market, means is open to discussion.
Bill Fleckenstein:
But I was wondering if you have thought about what that might look like, and given the fact that the FED has threatened yield curve control, seems like they’ve threatened it. Would we be wiser to look at the corporate bond market and maybe seeing spreads move out at some point because inflation expectations have ratcheted up and people express that there, we would see credit spreads widen, not because of inferior credit, just because people want a little bit more? So what would you think about, what losing the bond market might look like or is that even a good way to think about things?
Jim Grant:
I think it’s a very good way of looking at things. First as to yield curve control. I think it is here. It’s not here in name, but it is here in fact. The VIX is a measure of volatility in stocks, the so-called move index, M-O-V-E. Move index is a measure of volatility in bonds. The move index, which comes out of Merrill Lynch and who…
Grant Williams:
Bank of America.
Jim Grant:
Yeah, Bank of America. Now it is at it slows. It goes there, it goes back long enough to make it slow and significant. The volatility of the bond market is dead and the 10-year yield, which I guess is the current benchmark is moved within 10 basis points in many, many months. Between 60 days it’s gone into 70 odd. But I say, regardless of what the latest speech of the latest Fed governor is all about, I think the market has decided that yield curve controls is a fact. The suppression of yields is a fact.
Jim Grant:
Alright, so what does that mean? Well, it means that if there were to be an unscripted inflation, the Fed would have to decide what to do. Presumably, people would want fewer of these securities if it could be demonstrated, not through one, and not seemingly anonymous, authorized monthly CPI report, but a succession of them and the evidence of a gathering trend.
Jim Grant:
The Fed, if it were intent upon suppressing these yields, would have to work harder, meaning, would have to buy more, meaning, we have to create more money with the wish to buy more. Now, what would people do about that and what would the Fed do? This is a very leveraged economy. The consumer has, in fact, powered down his or her borrowing since the last crisis, but corporate America has rather levered up and it seems as if every time the funds rate has gotten to two and a half or 3%, rivets start to pop in the collective balance sheets of American business. Grant, your contrarian friend Stephanie Pomboy was very quick to observe that and very pressured about that.
Grant Williams:
Yeah.
Jim Grant:
So, what would the Fed do if it were inclined to change tack and to work at bringing back inflation that was no longer nascent, but evident? They would have to do what? They’d have to sell the securities. They would have to go into the market and offer things that the market really didn’t want at the yields the FED would prefer to offer. They would have to be complicit, they would have to be a driver of a bear bond market.
Jim Grant:
Now, what would that mean to companies that had levered up to exploit the possibilities inherent in a negative real interest rate world, in a 0% funding world, in short, the world that we have been living in all these past 10 years? So, the Fed will have to decide between deflationary credit action and inflation at the checkout counter. What do you do? Well, I think the Fed is on record that its tipping its hand already.
Jim Grant:
In the face of that dynamic, the Fed was very late in moving to counter an inflation trend. And they welcomes it. The Fed has been talking in it’s speeches and it’s position papers about possibly doing makeup. If the Fed has been behind the curve on inflation, it wants 2%, only 2%, mind you, in that case, it must allow a little bit more inflation. We know that’s not going to work.
Grant Williams:
Yep.
Jim Grant:
The Fed is going to lose it and the Fed is going to, as you put it so well, they will lose the bond market. The bond market is going to start getting ahead of the Fed selling. The bond market has been getting ahead of the FED buying. It will unspool and reverse in its own time when, perhaps, some of us on this call have capitulated. I don’t intend to be the first one but you never know.
Jim Grant:
But look at the way this thing worked so perfectly with respect to financial asset bull markets in the past 10, 20, 30 years, they go back a long way these. And if it works the other way, people won’t recognize the pattern at first and it will be as disturbing as it is unprofitable. And that to me, that’s the End Game.
Grant Williams:
Jim, what do you think about negative rates in the US? Because if we look at the Fed funds futures, we can see that they’re basically pricing in negative rates next year.
Grant Williams:
The Mike Green, I’d offered him a chance to have a conversation with him, but he talked about what a huge event that would be in that it takes away that risk-free putt that pays his funds to own the 10-year as a putt against the market. In your mind, what do negative rates in the US mean for the United States and the world beyond that?
Jim Grant:
Oh, I do credit Chair Powell’s protests that he will more or less have to do it over his dead body. I think he is dead set against it. He’s only one vote of course, although certainly not the least important vote in the Federal Open Market Committee. I think they’re certainly very reluctant to do it notwithstanding the futures market and the federal funds futures market. Having said that, I think if it did happen, it would be a sign of the capitulation of the monetary authorities worldwide.
Jim Grant:
It would be the starting pistol for people to reconsider, again, I’m talking my book here, certainly, I’m talking not only my expectation, but I suppose my hope, it would be the starting festival for an orderly, thoughtful reconsideration of the nature of fiat currencies, and the cost and the damage that this radical monetary manipulation episode has caused everyone.
Jim Grant:
I hope it would be the invitation to consider alternatives and in the speculative realm I expect, to talk my own book, the Grants Interest Rate Observer book, it would be an invitation to own more of that monetary asset that has stood the test of time and that is not susceptible to Central Bank manipulation.
Jim Grant:
I think it would be a very important watershed, in the way that people thought about money, the management of money through central banks and the nature of money outside of the fiat world.
Grant Williams:
But as we talk about the End Game, sorry, because I don’t want to trample over here, but as we talk about the End Game, it occurs to me, when I hear you talk that way, that maybe that is the End Game that the world actually needs to play out, because without that starting pistol going off, without there being something that really forces that conversation to take place again, it’s certainly not one that anyone in any position of authority is going to want to enter into voluntarily. I mean, it seems that the world almost has to reach a point where this End Game is forced upon people. And Boomberg, they’re focusing on-
Jim Grant:
I agree. Look at what has happened to Judy Shelton.
Grant Williams:
Right. Yeah. Great point.
Jim Grant:
She was President Trump’s nominee. When the talk about the patience of job, she has been waiting for her shot at this, for the better part of three years. Consider what she has gone through in terms of mockery and the attempted destruction of her professional reputation, not because she advocates the gold standard, she is very very measured in all this, she thinks that the Treasury ought to sell gold denominated bonds as an experiment. Not to say that she’s not interested in gold, she is, but she reminds me a little bit in her views of this woman who just quit the op-ed page in the New York Times.
Grant Williams:
Right. Bari Weiss.
Jim Grant:
Weiss, just keep forgetting it.
Grant Williams:
Yeah, Bari Weiss.
Jim Grant:
Bari contends that she was driven out off the Times because she dared to hold opinions that were not yet the extreme. The counterpart is the Federal Reserve and it is all the way over, as it were, on the left with regard to money. Along comes a centrist with tendencies towards the right in the person of Judy Shelton, who, by the way, called the end of the Soviet Empire, well that Empire still exists, but she’s a woman who was used to thinking outside the box and who has demonstrated capacity, not only for thought and analysis, but also imagination, and she comes along and she is subjected to the most condescending, insulting reception than any Fed governor might have experienced, received.
Jim Grant:
That’s where the world is. So, yes, Grant people need some prod, they need to be reminded… not reminded, they need to be led into an open-mindedness about alternatives. Open-mindedness, now, is utterly absent. Certainly, it’s entirely absent from the economics profession. It’s mainly absent, even from Wall Street commentariat.
Bill Fleckenstein:
Jim, one question I wanted to ask you, which, given how often we speak, I probably should have done this before, but anyway, here goes. Is there anything we can learn about what ended the post World War II yield curve control, and what caused that to end that we might look for as a potential catalyst to maybe the psychology having changed about the bond market? I don’t really know what happened, but I know you must.
Jim Grant:
Well, yield curve control came in, I think, in 1942. The United States just entered the Second World War and the Treasury had a lot of financing to do. So, the Fed the… I forget now whether the Secretary of the Treasury was still an ex official member of the Board of Governors, but certainly, up until almost that time the Treasury had had a seat in monetary deliberations. Maybe that ended in 1935.
Jim Grant:
Anyway, it was a thing that was either in existence or in recent memory, but the Treasury virtually took over the Fed or at least leaned heavily on the Fed, said, “Okay. Now, we will peg the bond yields at so and so.” I forget what the yields were. I think the bond yield was at two and a quarter and I think the treasury bill yield was 5.821%. That was enforced from 1942 until 1951. What happened in 1951 was already, I mean mass skip the immediate post world war to experience.
Jim Grant:
In 1946, the rate of inflation in some months was in excess of 15%. Why? Because price controls were coming off and because all this pent up demand and wartime rationing had now loosed and was upon the economy and really yields was the cause for it.
Jim Grant:
It was impossible, you’re earning 2% on your securities and the inflation rate was called 12%. All right. Still, President Truman said we will not relax these yield curve controls because in the wake of World War One, controls would come off and people are taking a licking on their liberty bonds and then call.
Jim Grant:
So that was a mindset. So, controls were in place in 1951 when the Korean War was on, but the FED had said, “We have to do something.” So now William Mcchesney Martin then negotiating, “Inflation is coming on again and we cannot do this anymore.” So there’s something called the Fed Treasury Accord 1951, and that ended the formal control of the yield curve.
Jim Grant:
But what then happened was even more interesting, and then what happened was nothing. And the long dated Treasury was two and a quarter in 1946. In 1956, 10 years after the lows and five years after the end of the Accord, the long-dated Treasury yield was three and a quarter, 100 basis points only, of the rise in yields, despite the market hasn’t been pretty.
Jim Grant:
So it shows you so many things, it shows you… you never know, right? That’s one lesson I think I have learned. It shows you that the bond market can take its sweet time, especially in these trends, when they get started. And those three and a quarter of 1956 and then it was four and a quarter in 1956. For a secular bear market, this took its time to get started.
Jim Grant:
So, we can build these models and these dream castles for some of us, about how all this might end, but one possibility, it’s not the one I hope for, as a journalist, I’m in the volatility business, one possibility is that the trend ends, but ever so deliberately, and what happens, happens gradually. I don’t think that’s the case now because of the buildup of leverage and all these derivatives lying around waiting to be exploited, but that was what happened then.
Bill Fleckenstein:
I’m shifting gears, but on the similar topic of the end. One thing I’d really like to discuss is, what do you think about the prospects of the so-called Debt Jubilee or Cold Fusion and what might the world look like in its wake? I mean, obviously, if central banks were to start losing the bond markets of their various countries, obviously, if that were to happen in Japan, they got a pretty good hand to play, to just swap their bonds for some longer-dated bonds with no yield. Do you have any thoughts on the likelihood of Cold Fusion or a Debt Jubilee? Even if you don’t think it’s very likely, maybe, you could comment on, what might the world look like if Japan did that? I think it’s an interesting intellectual exercise.
Jim Grant:
Well, here’s something that Japan did. In the 1930s, the Japanese were great anglophiles, they admired British institutions, especially in the monetary realm, the Bank of Japan was a devoted student of the words and deeds of Governor Norman who was the head of the Bank of England. And Norman was a gold standard guy and the Japanese wanted to get back on the gold standard after World War One.
Jim Grant:
And they finally did, they finally did in 1931, just in time to watch the British depart the gold standard. So what happened when the Japanese were on it, but the world was moving off it? Was that the Yen appreciated, the Japanese export market collapsed, commodity prices collapsed and the governor of the Bank of Japan was assassinated, he’s last name was Inoue. He was assassinated by a kid from the countryside that was a member of a blood oath association or something like that. And he was reacting to what seemed a very hostile and heartless form of alien capitalism, so they assassinated the Governor of the Bank of Japan.
Jim Grant:
And so they took a hit at the Bank of Japan and they got us a gold standard. What happened then was the biggest day in the history of the Tokyo Stock exchanges, they closed it early because of the riot to the upside. And that wasn’t a Debt Jubilee exactly, but it was an Inflation Jubilee. That’s a long time from now, so, let’s look a little bit nearer in history to what has happened in this country.
Jim Grant:
Well, not exactly a Debt Jubilee but an Inflation Jubilee to be sure, on August 15th 1971, Nixon took us off the Bretton Woods gold standard. That was a Sunday evening, on Monday morning, the stock exchange opens, what will do? The dollar has lost its foundation, the United States has defaulted, we have proven faithless in our pledge to redeem, orthodox finance is, if not dead, certainly imperilled. When we do, the stock market was up the most ever, that was a record upside day to that moment in the stock exchange’s history.
Jim Grant:
Such events I think, if there were a move to renounce debt or to institutionalize inflation in some way or to make a more manly effort to debase the dollar. These guys really haven’t started, I could do a better job than they could. I better demonstration burning of about 2000 pounds of hundred dollar bills in the front lawn of the Federal Reserve building just to open it. But if there were such a thing, I think the stock market on form, would be a beneficiary.
Jim Grant:
I can’t imagine the gold market not being one. But here’s a little mind experiment. What would happen if the FED began to do QE but the use of proceeds was to buy up outstanding debt and then to stockpile it and then to engage in the Treasury with some gentleman’s agreement, and then we’ll stockpile it and you hold us harmless against anything resembling marked market losses impairment, the balance sheet, by Treasury’s already done that. You can see that happening, right?
Grant Williams:
Yeah, yeah. sure.
Jim Grant:
These things might seem far fetched but they have precedents and I don’t think these were far fetched. I think the time is now, but what do I know about timing?
Grant Williams:
Which is always the tricky part.
Jim Grant:
But then I think the world has too much debt, I think the world perhaps has too much debt in relation to the cash flows available to service that debt, that’s a more precise way of saying too much debt. So what do you do about that? You can inflate it away but that seems to be easier said than done, which my goodness, it was always thought that human beings could procreate and debase. That turns out that falling birth rates and disinflation are calling into question even those verities. But I don’t know, I think there might be such a thing and on the evidence of history, such a thing would be rather welcomed.
Grant Williams:
Does this mean that we’ve reached the point where, perhaps there is now too much debt to inflate because that was always the preferred option, I guess?
Jim Grant:
Yes. I don’t know if that’s the case. I think that the very thoughtful and very successful bond bulls such as Van Hoisington and Lacy Hunt, I think that is their position. But, I don’t know, I’m sorry to end this on a note of the most perfect ignorance, but I just simply don’t know.
Grant Williams:
Jim, there’re a few people who will say, “I don’t know.” When they don’t know, most people will come up with an answer. So, we appreciate that just so much, trust me.
Bill Fleckenstein:
I would have said that there was too much debt in Japan at the government level, to inflate away many years ago when they went down this path and they’ve got half of it under control and, basically, they’ve euthanized the bond market there. So, who knows how much too much is supposed to be?
Grant Williams:
Well, we’ll [inaudible 01:03:41] now.
Jim Grant:
That’s my answer.
Bill Fleckenstein:
What are friends for, Jim?
Grant Williams:
Said in your best Frankenstein voice. Jim, listen, thank you so much for giving us this time.
Jim Grant:
Oh, you’re welcome.
Grant Williams:
It’s always a thrill to hear you and to get a chance to chat with you. So, we will make sure… I know you’re going to jump off, we will make sure that we let everybody know, who doesn’t know how to follow you, how to follow you when we wrap up shortly, but we’ll let you jump and thanks so much again for your time.
Jim Grant:
Thank you, fellas. What fun. Okay.
Bill Fleckenstein:
Thanks Jim.
Jim Grant:
Bye.
Bill Fleckenstein:
It’s so funny. I talked to Jim pretty regularly and I’ve read all of his financial history books and all the other ones and every now and then, he just spews a bunch of stuff I had no idea about. From the top of his head, he was going through all that stuff from the ‘40s, ‘50s and ‘60s. I just think it’s useful for people to get shaken out of this mindset that we have today and realize how different things were with underlying variables, at least at a headline rate, that worked so different. I mean, this gets back to one of my hobbyhorses, the whole psychology of things, but anyway.
Grant Williams:
But it’s true, when you listen to Jim talk, and you know what baffles me is when the CNBC’s, the Foxes of the World and Bloomberg have Jim on and then they don’t let him speak. I mean, you could sit here and listen to Jim talk all day long and interrupting him when he’s in a flow like that is doing a disservice to the listeners, to the viewers, to everybody, because his knowledge is just unbelievable.
Grant Williams:
And I think you’re right, as I was listening to him, run us through that period, which I was very keen to have him do, because, as I said, I’m listening to it, and I’m just going, check, check, check. And the conditions are all in place and I think that’s the important thing to understand.
Grant Williams:
It might be a horse of a different color but we have everything in place for a repeat of a situation that’s happened before and I think that’s the important thing for people to realize when you do get to these extremes, where you believe that extrapolation is your friend and things can never change and it will always be this way, that’s precisely the time when you need to start really thinking hard about the opposite outcome.
Bill Fleckenstein:
Yeah. Well said differently it’s when people are so convinced that things can’t change, then they’ve acted on that and it has to go on long enough to have had enough people act on that to really embed the mindset. When Jim was talking about that period, he brought back a couple of memories for me, which I didn’t want, at the time as I didn’t want to disrupt him. But I’ll never forget when those Treasury came at 15%. Sam Nakagama was the economist at Kidder Peabody, which is where I was.
Bill Fleckenstein:
And he was making the case that you shouldn’t buy the 15% coupons because rates were going to 16%. And why would you want to buy? And I remember, not long thereafter, when people invented zeros, the period where he talked about in ‘84 when real rates went back to about 1000 because rates backed up to 13 or 14 and I was running equity money at the time and we were buying zero-coupon bonds because they guaranteed a better rate of return and you’re probably going to be able to get out of the stock market.
Bill Fleckenstein:
There’s value here, even if no one believes that the trend is going to change, which is exactly the opposite what we have now, there is no value guaranteed, you can’t make anything except if you trade them on a spike and yet all the trends are in place to make that change. So it seems to me that if you couldn’t change people’s minds easily, in 84, when rates backed up to 13% to 14% and underlying inflation was four or five.
Bill Fleckenstein:
And you’re getting a real proposition to take the other side of that process. Now, you’re not really getting anything. So, it’s taking longer to make the trend change, because to bet against that, now you have to short the zero-coupon bond instead of buying the 14 percenter. And that’s not really such an interesting thing to do.
Bill Fleckenstein:
So, I think that may explain why this is maybe a harder trend to change, that and of course the fact that there’s so much monetization going on which would make bonds worth less over time, but in the short run perhaps worth more because of the flow of funds, etc.
Grant Williams:
Yeah, it’s funny, as we’ve gone down this journey to figure out the End Game, we’ve been talking about bond markets, but we haven’t really had that conversation, that we have had with Jim there, about maybe looking at it from the fiat versus hard money. Maybe that is the End Game. Maybe the End Game is just a return to the gold standard of some form which again is something I’ve spoken about in the past and it makes sense to me and it would be a natural bookend to the period from 1971, when really all this began, to be put right back where we were. And let’s face it, right back where we’ve always gone throughout human history.
Bill Fleckenstein:
Right, other than the fact that, that would impose the discipline on the central bankers and politicians, which they’re not going to be keen to have. We would need to get to the part where taking some medicine and getting on a sound standard seems to me, we would need a ton of pain, to get people to want to do that.
Grant Williams:
For sure. I made this point in a presentation I gave a couple of years ago called Cry Wolf, talking about what you need for a return to the Gold Standard and people always talk about it as if it’s a choice, as if one day we wake up and think, “Maybe we should go back to the gold standard.”
Bill Fleckenstein:
Right. Good point.
Grant Williams:
And my point has always been, it’s never a choice, it’s the answer to a problem that leaves you no choice. And at the time I gave the presentation, I said the other conditions you need for this to happen are political unrest, social unrest, and market unrest. And we had the first two, but we didn’t have the third and so as we go through this, whether it’s equity market unrest like we saw in March and bond market unrest or the Fed losing the bond market.
Grant Williams:
All the other pieces of that puzzle are in place now for a return of some to sound money. Let’s not call it a gold standard because that’s become such a pejorative phrase.
Bill Fleckenstein:
Right.
Grant Williams:
But a return to sound money of some sort seems, at this point to me, inevitable. I mean, not imminent, certainly, but inevitable.
Bill Fleckenstein:
Grant, I think that’s right but obviously that’s a step or two ahead of where we are.
Grant Williams:
Yeah, yeah. That’s the end, End Game.
Bill Fleckenstein:
Yes. That’s the end of the End Game.
Grant Williams:
Let’s go one step at a time, you and I, shall we?
Bill Fleckenstein:
Yeah, yeah. Okay.
Grant Williams:
This one is long enough. Well, again, a fantastic conversation, as we knew it would be with Jim. For those of you that aren’t aware, God knows how that’s possible, but if you don’t subscribe to Grants Interest Rate Observer, then you absolutely should, I mean, it is a Bible in the investment world and has been since, I think 1980, I think Jim started writing it.
Grant Williams:
You can find it more at grantspub.com. Jim also has a Twitter account, again, it’s @grantspub and they release all kinds of podcasts and information there that is just so, so valuable, Bill, yeah.
Bill Fleckenstein:
Yeah. And they also have an almost daily feature on the site, too. I don’t know if you actually have to be a subscriber to get that or not.
Grant Williams:
No, you don’t.
Bill Fleckenstein:
So therefore folks who are on a tighter budget and don’t think they can afford it, you can avail yourself of his wisdom by just going to the site and noodling around and finding stuff which is worthwhile doing.
Grant Williams:
Absolutely. And so I guess all that remains, again, is to thank you for listening. If this is the first time that you’ve joined us, and it was the star name of the market, Mr Jim Grant that brought you here, then please, please do go and check out our previous podcast with James Aiken and Mike Green, because again, the feedback for those have been remarkable, and thanks to all of you who’ve left feedback and given us reviews and ratings on iTunes. If you haven’t done that, and you could take a moment to do it, we would greatly appreciate it, it really, really helps.
Grant Williams:
In the meantime, we will leave you with our thanks. If you wish to follow me on Twitter you can do so at @ttmygh.
Bill Fleckenstein:
And I am @fleckcap.
Grant Williams:
Yes, he is. We will see you next time. Thanks so much for listening. Nothing we discuss during the End Game should be considered as investment advice. This conversation is for informational and hopefully entertainment purposes only. So while we hope you find it both informative and entertaining, please do your own research or speak to a financial advisor before putting a dime of your money into these crazy markets.
