Last week, the Fed added new programs and upsized many of the loan and bond buying programs it had already announced over the past several weeks. It is now traveling on a road without an exit in sight. It’s almost certain that withdrawal of this new support will be slow. In the near-term, it has already significantly dislocated (tightened) both investment grade and (to a lesser extent) high yield (HY) prices relative to their fundamental cash flow profiles.
Let’s call out these new “liquidity programs” for what they really are. The PMCCF and SMCCF (Primary and Secondary Corporate Credit Facilities) are targeted to help large, low-investment grade companies like Ford, whose bonds popped from 70 to 83 on the news of an upsize to the facility. The program extends support without the political fallout a new TARP (Troubled Asset relief Program) might cause.
PMCCF and SMCCF are TARP in disguise.
While extensive, I believe these varied programs will not prevent the default cycle that is coming in the BB+ and below universe. Default rates will be lower than without these programs, but not low enough to support current risk-asset values. The “exigent circumstances” to which the Fed is responding are unlikely to be short-lived, especially because corporate leverage was already so high before the pandemic began and earnings were already so weak. After today’s tightening in high yield spreads (CDX to ~500bps and HYG YAS ~600bps), we continue to believe there is little upside to ownership of U.S. high yield – even after the announcement of these expanded programs (likely to expand even more).
We believe risk-reward to U.S. equities in particular is still skewed massively to the downside, and for the Fed to take the action it took today, it must see circumstances as being dire indeed.
We wrote on March 29th that a rally to 2700 to 2,800 could occur and that it would be a fade. We expected short squeezes in credit and equities on program announcements – those program announcements came faster than expected. We maintain that view. For the S&P to trade at 2,800, it requires a 19.5x forward earnings-per-share multiple on $145 in EPS (down a mere 10% YoY). That EPS estimate is probably far too conservative and earnings could easily fall 20% (with average recession EPS down between 20% to 30%). At S&P EPS down 20% ($130), 2,800 on the S&P requires a 21.5x forward multiple. Can large cap equities really sustain that multiple given the risks to cash flows? Can small cap stocks (Russell 2000) sustain a forward multiple of almost 40x given the inevitable defaults that will occur in BB+ credits and below? We don’t think so. Recall that equity is the residual in every capital structure and is first loss.
While the buying is currently occurring across the universe of high yield bonds, we believe worsening fundamentals will drive dispersion amongst high yield credits over time. The sub-BB+ universe will become an orphan… at least until the Fed buys it, too. Moreover, the speculative grade loan market was already strained before the pandemic began; loan volumes are likely to continue to fall – albeit even faster now. Fed programs will prevent disaster, but they won’t continue to support current equity and credit valuations as fundamentals deteriorate. HY spreads have fallen from just under 900 (CDX HY) to 530bps (as low as 475bps) on Fed euphoria. So, lets query something. Even with Fed support, do HY spreads at 500bps make sense on the cusp of the most severe recession since 1929? We think not.
Since 2008, in order to justify extraordinary policy actions (including company bailouts), the Fed has been using the Section 13(3)’s exigent circumstances exception to the specific direction provided for open market operations under Section 14 of the Federal Reserve Act (FRA). The Fed began again on March 15th by establishing numerous Treasury-funded SPVs (Special Purpose Vehicles) that it will lever to provide financing under TALF, two investment grade buying programs, and CPFF amongst others, which we summarize below. Today, it upsized many of those programs. These corporate bond buying programs will be extended through September of 2020. There are nine programs in total.
For years, the conversation around the prospect for “Japanification” of U.S. monetary policy was almost universally met with extreme skepticism. The use of Section 13(3) now places the U.S. almost side-by-side with Japanese policymakers, and it is incumbent upon us to understand the implications of this progression. Where will it eventually lead U.S. monetary policy? Certainly, there is no policy space left. Monetary policy has been come completely palliative rather than stimulative. Will continued intervention destroy the very free market system it is attempting to save? We would argue that now is precisely the right time to ask this question. Japan serves as a vision of one possible future self for the US.
We investigate both the Fed’s authority to implement BoJ-style policy as well as the practical near and long-term implications. We’ll review each of the policies the Fed has undertaken or is likely to undertake (alongside and in coordination with fiscal policy). On March 20th and just prior its re-implementation, we had already suggested that the 2008 playbook would reemerge. Next, we’ll touch on the next stop on the slippery slope – the Fed buying equities and a broader swath of high yield corporate bonds. It can presumably continue to justify such actions as the next extension of its Section 13(3) powers.
We conclude that, while monetization of deficits serves a legitimate purpose of helps prevent unintended consequences in rates markets, buying equities would do little but further distort asset prices. This already extant distortion (due largely to quantitative easing) helped to create the fragility and lack of policy space that makes the current Covid-19 Tsunami so hard to combat. At this point, monetary policy alone can’t combat the 100-year disaster. It must work as the mechanism to monetize the debt required to fund the fiscal policy response. Importantly, this means Fed action should receive additional checks and balances from the legislature. In our view, Treasury-only supervision just doesn’t cut it. Our system is one of checks and balances… yet, there are none in this instance. Should there not be?
Throughout history, liberty is almost always denied when governments assert that exigent circumstances require it. Let’s look at a constitutional analogue. The Fourth Amendment to the U.S. Constitution prohibits ‘unreasonable’ searches and seizures. Said differently, the Fourth Amendment prevents the government from unreasonably taking or infringing upon an individual’s property or privacy rights. To that end, it sets requirements for issuing warrants: warrants must be issued by a judge or magistrate, justified by probable cause, supported by oath or affirmation, and must specify the place to be searched and the persons or things to be seized.
Exigent circumstances may provide an exception to the Fourth Amendment’s protections when circumstances are dangerous or obviously indicate probable cause. The application of exigent circumstances has been highly adjudicated – meaning, the courts found it necessary to rule often on its application to assure the government’s propensity to overreach was checked. One such permissible example of justifiable exigent circumstance is the Terry stop, which allows police to frisk suspects for weapons. The Court also allowed a search of arrested persons in Weeks v. United States (1914) to preserve evidence that might otherwise be destroyed and to ensure suspects were disarmed.
The health of the public and of the police officers justified the infringement on privacy. Other circumstances might justify police to enter private property without a warrant if they have plain sight evidence that a violent crime is taking place. Importantly, there are many examples of situations in which exigent circumstances were ruled insufficient to justify the infringement on personal or property rights. For example, even if a suspect was carrying a gun (an exigent circumstance), while reasonable to ‘stop and frisk,’ it would not necessarily justify the extreme action of locking him/her up indefinitely until a search of his home could be conducted.
We think this 4th Amendment construct is an incredibly useful analogy for understanding the danger in the Fed’s actions now; there’s a reason the very same phase – exigent circumstances – is used in 4th Amendment cases as well as in the Federal Reserve Act. We are not arguing that the present economic circumstances are not exigent, but we are arguing that there must be due process to assure that a valid justification does not lead to overreach. That overreach arguably started today as the Fed expanded its program into HY. Unlike legal challenge under the Fourth Amendment, Section 13(3) is not subject to a well-defined process by which it may be challenged and by which ‘lines may be drawn.’ Lack of due process almost invariably leads to government overreach.
The current Japanification of policy – if gone unchecked by Congress – is the beginning of the socialization and consequent destruction of free capital markets.
In our piece Monetize It – Monetize All of It, we suggested it would be necessary for the Fed to monetize all the upcoming deficits that would be needed to fund coronavirus relief programs. We were clear to suggest that the coordination should be explicit and with the appropriating authority – i.e. – Congress. Dodd Frank amendments to the Federal Reserve Act did not have the foresight to modify 13(3) checks and balances beyond Treasury approval. The Fed is now using this loophole to skirt the explicit mandate provided for in Section 14 – without due process to ascertain where the line ought to be drawn.
In the case of Japan, we can see what we’d consider an undesirable monetary policy outcome orchestrated by a stealthy government takeover of large swaths of private industry. Last year, the Bank of Japan (BoJ) bought just over ¥6 trillion ($55 billion) of ETFs and now holds close to 80% of outstanding Japanese ETF equity assets. Total purchases to date represent around 5% of the Topix’s total market capitalization. According to the latest Nikkei calculations, not only has the BOJ also become the top shareholder in 23 companies, including Nidec, Fanuc and Omron, through its ETF holdings, it was among the top 10 holders for 49.7% of all Tokyo-listed enterprises. In other words, the BOJ has gone from being a top-10 holder in 40% of Japanese stocks last March to 50% just one year later.
The BoJ is not an independent central bank, so it receives explicit legislative authority to act when it buys non-governmental assets. We doubt Congress would allow that here – as Congress might actually recognize the Constitutional implications. Surely, the courts would.
Monetary policy in its Japanified form has mutated into an incredibly stealthy ‘taking’ of Japanese citizens’ private property under the auspices of the public good.
Arguably, if unchecked, the BoJ could end up owning all private assets under the auspices of supporting the economy. Is this something we should tolerate here in the US, the greatest capitalist democracy the world has ever seen? We say no.
The Fed Facilities
So, thus far, what has the Fed done? We predicted much of it. On March 20th in Monetize It – Monetize All of It, we wrote:
“To state the obvious, today’s crisis differs from 2008. Thus, the policy response should also differ. As we know, many of the Fed-provided credit facilities from 2008-era were designed to bail out banks, but the powers of section 13(3) of the Federal Reserve Act were also extended to companies. Banks remain key as that’s how all policy is transmitted (at least in part), so we’ve suggested clients expect facilities like CPFF (Commercial Paper Funding Facility – already done), TLGP (Temporary Liquidity Guarantee Program) and others. We might also expect an expansion of the PDCF (Primary Dealer Funding Facility) collateral or a modification to haircuts. Under 13(3) we might also expect a TALF-like facility (Term Asset-Backed Securities Loan Facility) and a TARP (Troubled Asset Relief Program).”
If the Fed extends it logic under Section 13(3), all high yield bonds (not just fallen angels and the HYG ETF) and equities will be next. This would be pure folly with the drastic unintended consequences that Japan has already begun to face.
Let’s get granular around what facilities the Fed has established, how much liquidity they provide, and what authority allows the. We will include a discussion of the collaboration between the Fed and Treasury through the Exchange Stabilization Fund (ESF) and how the Treasury funds the ESF through special purpose vehicles (SPVs) which it may then leverage based on collateral provided.
Commercial Paper Funding Facility (CPFF) – March 17th.
The CPFF facility is structured as a credit facility to a SPV authorized under section 13(3) of the Federal Reserve act. The SPV serves as a funding backstop to facilitate issuance of commercial paper. The Fed will commit to lending to the SPV on a recourse basis. The US Treasury Dept., using the ESF (Exchange Stabilization Fund) will provide $10 billion of credit protection to the Federal Reserve Bank of New York in connection to the CPFF. The SPV will purchase 3-month commercial paper through the New York Fed’s primary dealers. The SPV will cease purchases on March 17th, 2021 unless the facility is extended.
Primary Dealer Credit Facility (PDCF) – March 17th.
The PDCF offers overnight and term funding for maturities up to 90 days. Credit extended to primary dealers can be collateralized by a range of commercial paper and muni bonds, and a range of equity securities. The PDCF will remain available to primary dealers for at least six months, and longer if conditions warrant an extension.
Money Market Mutual Fund Liquidity Facility (MMLF) – March 18th.
The MMLF program was established to provide support and liquidity of crucial money markets. Through the program, the Federal Reserve Bank of Boston will lend to eligible financial institutions secured by high-quality assets purchased by financial institutions from money market mutual funds. Eligible borrowers include all U.S. depository institutions, U.S. bank holding companies, and U.S. branches and agencies of foreign banks.No new credit extensions will be made after September 30th, 2020 unless the program is extended by the Fed.
Primary Market Corporate Credit Facility (PMCCF) – March 23rd as amended April 9th.
The PMCCF will serve as a funding backstop for corporate debt issued by eligible parties. The Federal Reserve Bank will lend to a SPV on a recourse basis. The SPV will purchase the qualifying bonds as the sole investor in a bond issuance. The Reserve Bank will be secured by all the assets of the SPV. The Treasury will make a $75 (up from $10) billion equity investment in the SPV to fund the facility and the SMCCF (below), allocated as $50 billion to the facility and $25 billion to the SMCCF. The combined size of the facility and the SMCCF will be up to $750 billion (the facility leverages the Treasury equity at 10 to 1 when acquiring corporate bonds or syndicated loans that are IG at the time of purchase. The facility leverages its equity at 7 to 1 when acquiring any other type of asset).Eligible issuers must be rated at least BBB-/Baa3 as of March 22nd by a major NRSRO (nationally recognized statistical rating org). If it is rated by multiple organizations, the issuer must be rated BBB-/Baa3 by two or more as of March 22nd.The program will end on September 30th, 2020 unless there is an extension by the Fed and the Treasury.
Secondary Market Corporate Credit Facility (SMCCF) – April 9th.
Under SMCCF, the Fed will lend to a SPV that will purchase corporate debt in the secondary market from eligible issuers. The SPV will purchase eligible corporate bonds (must be rated BBB-/Baa3, see above for full criteria) as well as ETF’s that provide exposure to the market for U.S. investment grade corporate bonds. Today, the Fed also indicated that purchases will also be made in ETF’s whose primary investment objective is exposure to U.S. high-yield corporate bonds. The Treasury will make a $75 (up from $10) billion equity investment in the SPV to fund the facility and the PMCCF (above), initially allocated as $50 billion to the PMCCF and $25 billion to the SMCCF. The combined size of the facility will be up to $750 billion (the facility leverages the Treasury equity at 10 to 1 when acquiring corporate bonds or syndicated loans that are IG at the time of purchase. The facility leverages its equity at 7 to 1 when acquiring corporate bonds that are below IG, and in a range between 3 to 1 and 7 to 1 depending on the risk in any other type of eligible asset).The program will end on September 30th, 2020 unless there is an extension by the Fed and the Treasury.
Municipal Liquidity Facility (MLF) – April 9th.
The MLF, authorized under Section 13(3) of the Federal Reserve Act will support lending to U.S. states and cities (with population over 1 million residents) and counties (with population over 2 million residents). The Federal Reserve Bank will commit to lend to a SPV on a recourse basis, and the SPV will purchase eligible notes from issuers at time of issuance. The Treasury, using funds appropriated to the ESF, will make an initial equity investment of $35 billion in the SPV in connection with the facility. The SPV will have the ability to purchase up to $500 billion of eligible notes (which include TANs, TRANs, and BANs). The SPV will stop making these purchases on September 30th, 2020 unless the program is extended by the Federal Reserve and the Treasury.
Paycheck Protection Program Lending Facility (PPP) – April 6th.
The PPP facility is intended to facilitate lending by all eligible borrowers to small businesses. Under the facility, Federal Reserve Banks will lend to eligible borrowers on a non-recourse basis, and take PPP loans as collateral. Eligible borrowers include all depository institutions that originate PPP Loans. The new credit extensions will be made under the facility after September 30th, 2020.
Term Asset-Backed Securities Loan Facility (TALF) – March 23rd.
The TALF is a credit facility that intends to help facilitate the issuance of asset-backed securities and improve asset-backed market conditions generally. TALF will serve as a funding backstop to facilitate the issuance of eligible ABS on or after March 23rd. Under TALF, the Federal Reserve Bank of NY will commit to lend to a SPV on a recourse basis. The Treasury will make an equity investment of $10 billion in the SPV. The SPV initially will make up to $100 billion of loans available. Eligible collateral includes ABS that have credit rating in the long-term, or in case of non-mortgage backed ABS, short-term investment grade rating category by two NRSROs.No new credit extensions will be made after September 30th, 2020, unless there is an extension.
The Main Street New Loan Facility (MSNLF) and Expanded Loan Facility (MSELF) – April 9th.
The MSNLF and MSELF are intended to facilitate lending to small and medium-sized businesses by eligible lenders. Under the facilities, a Federal Reserve Bank will commit to lend to a single common SPV on a recourse basis. The SPV will buy 95% participations in the upsized tranche of eligible loans from eligible lenders. The Treasury will make a $75 billion equity investment in the single common SPV that is connected to the facilities. The combined size of the facilities will be up to $600 billion. Eligible borrowers are businesses up to 10,000 employees or up to $2.5 billion in 2019 annual revenues. The SPV will cease purchasing participations in eligible loans on September 30th, 2020 unless there is an extension by the Fed and Treasury.
The $2.3 trillion in loans announced this morning is made up of the Fed’s nine programs, including leverage on the Treasury’s equity contribution to SPVs under the ESF. Specifically, the Commercial Paper Funding Facility accounts for $100 billion of loans, while the Primary and Secondary Market Corporate Credit Facilities account for $500 billion and $250 billion respectively. The Municipal Liquidity Facility (MLF) adds another $500 billion, while TALF makes up another $100 billion. Finally, the Main Street New Loan Facility (MSNLF) amounts to approximately $600 billion. Together, these specified facilities account for ~$2.05 trillion of the announced $2.3 trillion. As we understand it, the remainder of the contribution flows to the Paycheck Protection Program (PPP), the Money Market Mutual Fund Facility (MMLF), and the Primary Dealer Credit Facility (PDCF).
Despite an unprecedented intervention over the weekend from the Federal Reserve, which cut short-term interest rates to close to zero and introduced emergency lending measures, the U.S. stock market fell sharply again on Monday. By the close of trading, the Dow Jones Industrial Average had fallen almost three thousand points—the worst single-day points loss in history—or thirteen per cent. The market is now down by almost a third from its peak, in late February.
Clearly, investors are spooked by the widening coronavirus outbreak and the likely impact of the public-health measures that are being taken to deal with it. But what exactly is going on in the markets and the economy? In search of answers to this question, I spoke on Monday with Ian Shepherdson, the founder of Pantheon Macroeconomics, a firm that advises Wall Street firms, hedge funds, and institutional investors.
Shepherdson, who was formerly the chief U.S. economist at the international bank H.S.B.C., said that some investors were alarmed by the fact that the Fed felt obliged to act just a couple days before one of its regular policy meetings, and that they were also fretting about the delay in getting both chambers of Congress to pass an emergency spending bill. But Shepherdson also suggested that there were other factors at play, including some psychological ones. “To be brutally honest,” he said, “I think a lot of people on Wall Street didn’t take the virus seriously enough until it was their towns where cases were being discovered and their kids who were being sent home from school.”
Now the virus is impossible to ignore, and so are its economic consequences. “It’s going to be catastrophic,” Shepherdson said bluntly. “This is an economy built on discretionary consumption.” He was referring to all the nonessential purchases that people make in their daily lives, things ranging from new clothes and appliances to personal services such as spa sessions, meals in restaurants, and Uber rides. According to Shepherdson, all this nonessential stuff amounts to about forty per cent of the U.S.’s gross domestic product. In other words, it is enormous, in terms of both its dollar contribution to the economy and the number of people it employs.
As of yet, we don’t have any over-all figures for how shutdowns and curfews and self-isolation are impacting spending, but there are some preliminary indications. Over the weekend, movie-ticket sales fell forty-four per cent compared to the previous weekend. Shepherdson has been monitoring the number of people eating out through the booking site OpenTable. On Sunday night, the amount was down forty-eight per cent compared with the previous year. He read out some of the figures for individual states: “Alabama: down thirty-eight per cent. California: down fifty-five per cent. New York: down forty-seven per cent. New Jersey: down fifty-six per cent. This is just unbelievable.”
That was when most restaurants were still operating. Now that many states, including New York and New Jersey, have ordered them to close, apart from making deliveries, business is going to fall even more dramatically. The same is going to be the case for countless other enterprises, small and large. As they shut down, many of them are going to furlough their workers or let them go permanently.
This will result in a sharp rise in unemployment and in negative G.D.P. growth—in other words, a recession. “The U.S. economy is shrinking as we speak—I have no doubt at all about that,” Shepherdson said. On Monday, some Wall Street economists suggested that the G.D.P. could fall at an annualized rate of five per cent in the second quarter of this year. Shepherdson believes the downturn could be even more severe than that, with the G.D.P. contracting at a rate of about ten per cent. A collapse in discretionary consumer spending isn’t the only danger, he noted. As businesses react to the crisis, they will likely postpone a lot of capital spending, too. “We have no information about that yet,” he said. “But it is definitely going to get hit badly, as well.”
To alleviate some of this damage, economists of many different political persuasions agree that the Trump Administration and Congress need to introduce a substantial stimulus package on top of the coronavirus spending bill that the House of Representatives passed on Saturday. How big should these measures be? “I am in the one-trillion-to-two-trillion-dollar camp, preferably by dinner time,” Shepherdson said. “I think they should be just throwing money at people and businesses that are in the front line. Cash has to be given out to households. Cash has to be given out to small businesses. Cash has to be given out to gig workers. I don’t know what the figures are for Uber drivers, but they are probably catastrophic.”
It’s not just small businesses that are being affected, of course. Airlines, hotels chains, and other corporate entities are hemorrhaging money. Shepherdson said that some airlines could go bust “very quickly” if they don’t receive some sort of aid. “People say don’t bail them out—they’ve made billions of dollars in profits and paid their senior executives enormous sums,” he said. “I’m very sympathetic to that argument. But we are going to need an airline industry in September. So bail them out and sack the C.E.O.s. You can’t think in normal terms. This is more like a wartime crisis than a normal economic situation.”
Shepherdson isn’t the only economist making an allusion to the emergency measures that governments make in a war economy. “The world is de facto at war (against the virus, rather than against each other—this is the good news . . .),” Olivier Blanchard, the former chief economist at the International Monetary Fund, tweeted on Monday. He went on to point out that, during the Second World War, the federal deficit as a percentage of the G.D.P. rose to twenty-six per cent, as the Roosevelt Administration spent heavily on armaments and other programs. “Let’s not be squeamish,” Blanchard added.
Shepherdson agrees. “This is not a normal economic event in any way, shape, or form,” he said. “You have to be willing to think what previously would have been unthinkable.” If necessary, he said, the Federal Reserve could buy the bonds that the U.S. Treasury issues to finance a massive economic support package—a tactic known as “monetization,” which also was employed after the Second World War.
“Why do we worry about monetization?” Shepherdson said. “Because we are concerned about hyperinflation, but that isn’t an issue now, and we have a much bigger problem in our faces.” If the economy slumps in the way he thinks it is about to, a lack of adequate financial support for people who are adversely affected could lead to social unrest. “The first job of the government is to prevent social breakdown,” Shepherdson said. “If ever there was a case when quick government action could do that, then this is it.”
Transcript00:00another one of your publications is00:02carry with me is principles for00:04navigating the big debt crisis we follow00:06debt levels here we do debt reports debt00:08accumulation port set aside some00:10statistics this morning are you worried00:11about where we are in debt accumulation00:13at the household sovereign or global00:16level or are we near tipping points as00:20you look in debt accumulation around the00:22world are you concerned I’m I look at00:26things in a very mechanic mechanical way00:29and so what concerns me about debt we’re00:33in a new world now and what concerns me00:36about debt is the nature of the dynamic00:42in which you don’t have to service debt00:45and what I mean by that is to a larger00:48extent than ever before this debt growth00:51the maturity of the debt has been00:53extended a lot the interest rate becomes00:57negative or or near negative so the debt01:00service payments for the interest rate01:02go down a lot and it’s almost the01:06situation where there’s guaranteed debt01:09rollovers so principle does not have to01:12be rolled over in a number of cases and01:14there’s low covenants and so when you01:18start to look at this the thing you say01:20what is going to cause a debt service01:24problem in 2007 we calculated that we01:27would have the 2008 financial crisis by01:29doing those pro-forma numbers and then01:32when we’re dealing now in this seemingly01:34crazy or odd other reality in which the01:39you don’t have to pay interest and you01:42don’t have to rollover your debt and and01:45that and then you play with negative01:47interest rates you say how do how will01:50that work okay and so if we look at01:53periods of time in history and we’re01:55somewhat those types of things happen01:58maybe for example of war years one if we02:00look at the war years and we look at ya02:03let’s call year-old yield curve02:06targeting with the low interest rates02:09and the mechanics of that that produces02:11a different02:12mechanics now so when I look at what’s02:15ahead and I think about that and my02:18stretches my imagination because I I02:21know even beyond that we will have much02:24larger deficits so if we not only do we02:27have the debts that you’re referring to02:28right and their maturities but we have02:31will have larger deficits which will02:34grow and in addition we have pension02:37liabilities and healthcare liabilities02:39and other forms of liabilities that will02:42come at us02:42they’re very cashflow driven because02:45you’ll have to make those types of02:47payments and so they’re coming at us at02:49the same time and then you deal with02:51okay how will that be dealt with and02:54funded so you have to go through the02:56imagination of the fact that they will03:00probably be monetized and in other words03:03they’ll have debt03:04central banks will be in a position that03:06they’ll have to buy the debt and so as03:08we go from other countries let’s say if03:10we go from Japan which 46% of it’s very03:13large debt is owned by the Bank of Japan03:16and we keep moving that up that’s the03:19mechanics that we have in place and so03:21when I extend that and I look at that I03:23think we are in the last stages or the03:27less end of last stages of what is03:30currency what is a reserve currency how03:32does that monitor that our Fiat monetary03:34system work because let’s say currency a03:39bond is an asset that is a promise to03:43receive a lot of currency okay now how03:48do much do I want that and and because03:51I’m going to have let’s say a negative03:53interest rates are close to a negative03:55interest rate so you know then you start03:58to think of the arbitrage as do I want04:00the paper currency in the thing do I04:02want gold do I want some other04:04alternative type of currency and then04:07increasingly there will de facto be04:09taxes on owning that asset because tax a04:13negative interest rate is a form of04:14taxes and as we go more and more to04:16digital currencies the arbitrage between04:19putting cat paper in a vault will be04:23increasingly eliminated04:25so we’re at the when I talk about the04:27long-term debt cycle04:29I mean that there’s in in the history04:32you know you wipe out the debts and then04:34you don’t have debts but and then you04:37can create the stimulation and that04:40happens and you always hit it with a04:41jolt of stimulation until then you get04:45to interest rates hitting zero or close04:47to zero and then they don’t work so04:50that’s monetary policy one is interest04:53rates monetary policy two is then when04:56that doesn’t work you print money and04:57you buy it when that doesn’t work you05:00have this phenomenon that we’re in we’re05:03at the end of the long term debt cycle05:04and you have the dynamic so the classic05:08debt crisis that we’re looking at is05:12doesn’t look like the ones that I’ve05:15seen in the past it looks more like the05:18ones in the like and at one late-30s05:21what we’re at the end of that cycle05:23because in the past the way they would05:26happen would be you know do you have a05:28certain amount of debt central and the05:30economy’s overheating central bank05:32tightens monetary policy or even that05:35you run through and you say what’s the05:37debt rollover problem right so we’re not05:39going to have the classic debt rollover05:41problem we’re not going to have the05:43classic tightening of monetary policy so05:46when we think about those things and say05:48oh we’re going to have a debt problem we05:50have things to be concerned about in the05:52way I’m describing but they’re not going05:54to be the classic ways that this has05:57come to an end if we can’t afford the06:00liabilities and I agree that if you look06:01at the net present value of the US06:02government’s entitlement programs that06:04the gap the net present value is about06:0635 trillion and add to that 20 trillion06:09and federal debt and we’re adding a06:11trillion a year so huge sums of money if06:14to your point that we end up cancelling06:16or reducing those liabilities for every06:18liability that’s an asset so someone06:20who’s holding that asset is going to be06:21poor and there could be a distributional06:23piece of that so making to your point if06:26we simply write off the debt we’re06:28destroying a tremendous amount of growth06:29so the way that it’ll be done is by06:32printing it and evaluating the currency06:35because that’s the very subtle way and06:37it’s also06:38looks it looks good because when you06:41have a currency depreciation first of06:44all it’s very hidden tax right let’s put06:46a negative interest rate it’s not like a06:47tax rate change that’s a that’s06:49controversial you just have a negative06:51interest rate and okay that’s one that06:53form of tax and when you have a currency06:55depreciation it causes one’s assets to06:58go up06:59it’ll be inclined to make the stock07:01market go up depreciate the currency Iclerking on the floor of the New YorkStock Exchange in 1971 when the August15 1971 Sunday nightNixon floated the dollar right and Iwent on the floor of the New York StockExchange that clerking and I thought wowwe have a real crisis here and the stockmarket rose the most in my lifetimebecause a currency depreciation alsotends to raise asset prices in variousways so the the if you’re in thatposition the hidden way the effectiveway to do that is to monetize the debtand have the depreciation as distinctfrom like you write it down and like yousay somebody’s assets that doesn’t workwe cover these things in that book bythe way that book if you’re interestedprinciples for navigating big debtcrisis is available free online at08:03economic principles calm but it’s so08:07these things have happened over and over08:08again08:09I think mechanistically it means that we08:12will print the money that doesn’t mean08:15necessarily inflationary okay like in08:18the 1930s we had a series of currency08:21depreciations a lot of printing of money08:23but you also had the other forces that08:26meant that and so the Dinah I think08:28it’ll be kind of seemingly hidden but08:30it’ll but we’re still right close to the08:33point where nobody that you may not want08:37to own those bonds okay and you’ll look08:40for what else and the question is what08:44else what is that else okay that’s the08:47environment I think that will be it and08:49you know there’s a08:50that gold is the only asset you can have08:52that’s not somebody else’s liability so08:55anyway I don’t know what those08:58alternatives are but I would say if more09:01gold is more likely than the
John Mauldin has the big picture perspective of global economic trends to ask the difficult questions about societal change, inequality and automation of jobs. With the pervading need to monetize rising global debt, the Chairman of Mauldin Economics can only see a Bretton Woods type solution as the developed world starts to run out of difficult choices, while John also looks to the future of healthcare technology and the incredible breakthroughs in the pipeline. Filmed on May 22, 2017, in Orlando.