[Music] Consuelo Mack: This week on WEALTHTRACK, financial
thought leader James Grant on trends in debt, inflation and interest rates. James Grant: Interest rates are at
the ground level, at lawn level -- we see the manifestations of inflation.
I think we see it in the morality of our public finances. I think we see it on the
balance sheet of the Federal Reserve Bank of New York. The Federal Reserve Bank of New
York is leveraged 300-and-some times to 1. Consuelo Mack: The Editor of Grant's Interest Rate
Observer this week on Consuelo Mack WEALTHTRACK Announcer: Funding provided
by ClearBridge Investments, Morgan Le Fay Dreams Foundation,
First Eagle Investment Management, Royce Investment Partners, Matthews
Asia and Stategas Asset Management. Consuelo Mack: Hello, and welcome to this edition
of WEALTHTRACK. I'm Consuelo Mack. It can take a long time for a bubble to burst. Four years ago,
in 2017, Grant's Interest Rate Observer, a highly regarded financial newsletter, wrote an article
about the now infamous China Evergrande Group. Back then, it was anything but a familiar name,
except in China and among some institutional investors. The article was titled Ever
Higher as Grant’s published a chart showing the extraordinary rise in China Evergrande stock
price on the Hong Kong Stock Exchange that spring. As Grant’s noted then, we call the attention
of the readers of Grant’s to this situation because in the first place, everything about
Evergrande is incredible. The board of directors in 2016 earned 46.5 million dollars, JP Morgan
reports. And secondly, because we suspect that the company will one day become proverbial
like Bank of United States or Hindenburg. We'll fast forward to 2021. And indeed,
Evergrande, once the world's most valuable property stock, has become famous as the
world's most heavily indebted property company, with an estimated 300 billion dollars
in debt. It also could become Asia's largest bankruptcy as China's government seems
less and less likely to come to the rescue. Well, why should US investors care? What, if any,
significance does it have outside of China? That is where financial thought leader, journalist,
sleuth and historian James Grant comes in. Grant is the founder and editor of Grant's
Interest Rate Observer, a twice monthly journal about all interest sensitive investments,
which pretty much covers the waterfront. It is considered a must read by professional
investors at leading hedge funds, private equity and investment firms.
Grant is also the author of 9 books, including several financial histories. One
particularly relevant to the Evergrande situation is Money of the Mind: Borrowing and Lending in
America, from the Civil War to Michael Milken. It's about the forces that led up to the
credit binge of the 1980’s, one of America's biggest speculative booms at that time. I
started today's discussion with Evergrande, why it warranted Grant's reader's attention
back in 2017 and what it represents now. James Grant: Evergrande over leveraged,
preposterously unnecessarily diversified. The guy who ran it seemed as if he were like one
Jeff Bezos, about four Elon Musks. An amazing ambition, which was fine, but the
ambition was to build apartment buildings, many of which would remain unoccupied. They were for speculative purposes and not for
dwelling. Stock resembled as we imagined the Bank of United States from 1930. That one that didn't
do well. Or maybe the airship Hindenburg or some looming disaster. And needless to say,
this was not the time to have said that. Like six months ago, would have been good, the
stock went straight up. Also, the Evergrande was characteristic of the Chinese economy broadly.
The Chinese economy is enormously leveraged. Here's an amazing statistic that Chinese banking assets represent something
like 53 percent of the estimate for 2017 world GDP. Not Chinese world GDP, but world
GDP, slightly more than half of world GDP. Consuelo Mack: Wow. That was in 2017? James Grant: No. Well, this is right now. Consuelo Mack: Right now? James Grant: Yeah.
Consuelo Mack: Okay. James Grant: In 2017, Chinese banking
assets were also fantastically large in relation to everything, including the
world. So this seemed to us, the perfect model of what was wrong with China and
what's at risk with respect to China. Consuelo Mack: What's its significance now?
I mean, you saw this coming. You figured it would have to happen. But now what?
James Grant: Something like 22 percent of Chinese residential real estate is unoccupied.
And again, Evergrande is certainly worrisome enough in its own right, but more so as
indicative of the state of overleverage and rampant speculation that characterizes and
infuses the vast Chinese real estate business. The Chinese economy, to an important extent,
is driven by real estate speculation. Local government finance earns much of its tax
take on land sales. So Evergrande, again, is a thing in itself, and then it is a
symbol besides, and both are worrisome. Consuelo Mack: Do you think it's going to be, basically, isolated within China or
does it have greater ramifications? James Grant: I'm in the
greater ramification camp. Not so much because of the dollar denominated debt.
It's a small portion of Evergrande’s overall liabilities. But again, because it speaks to
the real estate speculative development model that is at the very center of the
second largest economy in the world. And President Xi, the Eternal President
of now the People's Republic of China, is lowering the boom on an enterprise broadly in
China and finance particularly and Evergrande’s failure or near failure, depending how
it plays out, will not brighten his mood. Consuelo Mack: Describe the forces
that are driving this overleverage that we're seeing now is a global phenomenon. James Grant: Yeah, we live
in a most remarkable time. This year, Consuelo, marks two important
financial anniversaries. One is the 50th anniversary of the abrogation of Bretton Woods.
That's President Nixon preempting the Great Horse Opera bonanza in August 15, 1971 saying
that henceforth the dollar would be a piece of paper and not exchangeable into gold at the
previously lawful rate of 35 dollars to the ounce. So that was one anniversary. We've had
that one 50th and we are now about ready to mark -- some of us -- the 40th anniversary
of the peaking of bond yields in 1981. So bond yields have been falling for 40
years, and the dollar has been increasingly plentiful, shall we call it, owing to
its detachment from its golden anchor. This is the 50th year of that separation.
What characterizes our finance in this country and broadly, the world over,
is a lot of paper money, a lot of liberality in lending and borrowing it. And interest
rates that are so tiny that it seems as if one could accumulate debt more or less without a
worry. That's the broad backdrop of where we are. Consuelo Mack: How concerned are you
about the amount of debt that you're seeing in this country and globally? And
what does it portend for bondholders? James Grant: Well, Consuelo, that's such a
great question, and it's such an interesting and paradoxical fact that the more debt we
have seen, the more better it has become for the bondholders. The US reached its first trillion
dollars in sovereign debt, and I think about 1981, if memory serves, which it infrequently does.
And today we're up to what? 28 or something? Consuelo Mack: Is 28 trillion
in US government debt? James Grant: About. Yeah, it’s about
that. That's the gross debt. Yeah, and very gross. The move from one trillion to,
let's call it, 28 trillion has been accompanied in the decline of the long bond yields from 15
percent to 2 percent. So a visitor from Mars would be hard pressed to understand why a lot of
debt is bad for bond prices or interest rates. So that's been the perplexing and most
interesting paradox in our -- we can agree -- state of over leverage is that up until
this point, it’s kind of been more than okay. But I think common sense tells you that a lot of
debt is fine and unobjectionable until such time as the as the holders of that debt decline
to roll it over and buy some more or until such time as the borrower finds it too
inexpedient to pay the principal and interest. Consuelo Mack: Yes, and inexpediency could be
encouraged by rising interest rates, right? James Grant: Yes. Consuelo Mack: Suddenly, it becomes very
expensive to finance and carry that debt. James Grant: Right, which so we have been speaking
with regard to Evergrande, is credit risk. Is the risk of the credit worthiness of the borrower.
With regard to US treasuries, the looming risk is interest rate risk as that risk is derived from
inflation and the expectations is for the same. So in the past couple of days, as we're talking
now, interest rates have most unexpectedly, the 10-year Treasury have gone from 125 to 145
-- 20 whole basis points up, which seems like nothing, but it has been enough to rattle a lot of
people. What's going on? And what may be going on is an inflation that is proving more persistent
than transitory. That's what may be going on. Consuelo Mack: The outcome of this paradox
that we've been talking about. Does it all rest in the laps of the FOMC with Fed officials? James Grant: That, too, is an interesting.
The Fed seems to be under the impression that it is in charge of events. But Consuelo,
my kind of subversive idea is that events will be increasingly in charge of the Fed is a huge
generation gap. I mean, everywhere, of course. Perennially there is the young people
just will not stop walking on the lawn. But on Wall Street, there is the interesting
generation gap opened between those who formerly young have still the most vivid
recollections of the inflation of the 70s, which, by the way, did not start in the 70s. It
got up and running in 1965 and by 1967, William McChesney Martin said that the horse of inflation
is out of the barn, so that's one generation. Consuelo Mack: Right. And he
was the Fed chair at that time. James Grant: Correct. And the younger generation,
which many of us would not mind being a part of except for their blindness with respect to this
thing that's happening to us now. If you have been in the business for the past 40 years,
you have seen nothing except falling rates and very little except for a flatlining
rate of inflation as measured. So there is general incredulity among
the people who are very active on Wall Street now. What is happening? Huh? They
just refuse to credit the possibility that inflation is, as William McChesney Martin,
the former chairman, says the horse of inflation said he, in the fourth quarter of 1967, 4
years before price controls came in. The horse inflation is out of the barn. And that
may or may not be true, but it's a possibility. Consuelo Mack: Right. So if you were to look
back to the 1960s before the horse of inflation got out of the barn, I mean, you know, it's like
asking a baseball analogy, what inning are we in? James Grant: I would say that the Fed that is
doubling its balance sheet in 18 months, that a Treasury that is issuing trillions of dollars
of debt, the proceeds of which are paying people not to work. The breakdown in supply chains, the
constellation of these episodes and phenomena, make me wonder, what did you expect?
World about inflation, I don't know, but there is a great debate and
formidable intellects are on the other side of this argument, and I have been arguing
the inflation side for more years. And I will confess to the viewers of WEALTHTRACK, I
have been R-O-N-G and I am [inaudible 0:13:20]. Consuelo, one of the things about inflation
is it's unpredictable. It just happens. Consuelo Mack: Well, no, Jim. It didn't just happen. Which is what you
said. What did you expect? It has been creeping up on us for a long time. You’ve
been writing about it for a long time. James Grant: I know. Let me try to explain
myself a little bit. In 1965, suddenly, a 1 percent rate becomes a 2-½ -- I forget --
2-½ or 3 percent rate. Now, inflation in 1960, ‘61, ‘62, ‘63, and ‘64 have been
running at less than 2 percent about. Less than the rate at which
the Fed would now panic. When I say it's unpredictable, nobody
issued a press release and there were none of the excesses then evident that are so much
on our front pages now. And yet inflation popped and persisted and accelerated
for the next 15 years. And yet the history of this
is very tricky, and dogmatism is a very hard thing to sustain in this particular
period of hours when everything is unexpected. For example, the economy is snapping back such that
personal income is up in the year of a pandemic. Consuelo Mack: Jim, you wrote a
recent lead article in Grant's titled The True Measure of Inflation.
What is the true measure of inflation? James Grant: I think at one important level,
inflation is a moral issue. The underlying moral problem with inflation is something for
nothing. It is a form of theft, it is a form of unlegislated tax. That's one aspect of inflation. An inflation aspect of it is the intuitive
phenomenon of redundancy of dollars. There's too many. I mean, there's an obscure Fed
function called the reverse repo operation. And we can simplify it. What it does is soak up unwanted
dollars from money market mutual funds and banks. Dollars that can't find a home in the money
market because there's no demand for it because there are simply too many of these
green pieces of paper. There's a 1 trillion 300,000 every day seeking refuge in the Fed,
so that's a measure of the redundancy of money. Consuelo Mack: That’s money
inflation, plain and simple. James Grant: And then there's the statistical
representation of inflation that we know is the CPI. And 30 percent of that is housing
costs. It's the cost of shelter, it's not house prices, it's a very important
distinction. House prices are up like 18 percent year over year, but that too
isn't. How can that not be inflation? Interest rates are at the
ground level, at lawn level, and so we see the manifestations of inflation.
I think we see it in the morality of our public finances. I think we see it on the balance
sheet of the Federal Reserve Bank of New York, the Federal Reserve Bank of New York
is leveraged 300-and-some times to 1. There's 4-¼ trillion dollars’ worth of
assets, there is 13-½ billion of capital. Consuelo Mack: That is scary. James Grant: Well, yes and no. Well,
it's scary, except the Treasury backs it up. See? The Fed is unanchored.
Therefore, it's undisciplined. Therefore, it is managed like an over-endowed economics
department at some university. It's not a banking institution, as it ought to be.
As I'm guessing, this is sermonizing now, Consuelo Mack: No, but it isn't. I mean, and
that's new in this era. That would not have been the correct right now on your Volcker.
This is a whole new ball game which you've written about. I want to nail down inflation.
I know it's really easy for you to do, Jim. So inflation, how real a threat is it
and how does the interplay between, 4000 year lows in interest rates and rising
inflation? I mean, how does that work as far as the financial markets are concerned,
as far as the impact on the bond market, James Grant: Well, inflation is the
greatest single risk that the viewers of WEALTHTRACK confront. And it's not just
that they're going to be skinned alive at the grocery store. It is that interest
rates are key determinants in the valuation of every single earning
asset -- stocks, bonds, real estate. Interest rates discount future cash flows. They
help us calibrate credit risk and set investment hurdle rates. They are the critical prices in
capitalism, and they have been suppressed. They are suppressed by central bank action. So to an
important degree, the valuation of everything in the portfolio of your viewers hangs by the
thread of the lowest interest rates in 4000 years. Rates, which are not anything -- I say I,
but the product of central bank manipulation to the downside so. Now, what changes
the structure of rates, what lifts them could be again, could be -- not to not
to dogma ties because it's unseemly. What that could be is, is an inflation
that persists, that frightens the Fed. It should frighten the Fed and
they start to move rates up. And stock prices fall, and the Fed says -- the
Fed is a very low threshold of financial pain, so what then? Rising rates of
inflation and a falling stock market. Consuelo Mack: Right, what then? James Grant: Yeah. So this is a whole new
panorama of possibility. It's quite exciting to think about. It's better to think about than
to sleep on. But this is the kind of thing that I think people ought to be thinking about is
what happens when the unscripted occurs. The unscripted in this case being a rate of inflation
that rises and persists and does not yield to the wishes and the press conference verbiage of
the chairman of the Federal Reserve Board. Consuelo Mack: Right. At some point, it
gets bigger than they are -- at some point. James Grant: At some point again, at some
point they don't control events. In the 1970’s, the Fed was at the mercy of Mr.
Market, Mr. Currency Market. Consuelo Mack: Why hasn't gold responded? James Grant: Gold is a deep disappointment
to its current fans. For background, the price of gold is up 50 times in 50
years. Consuelo, isn’t that a cool fact? Consuelo Mack: That's a cool fact.
Put it into context, though, whereas the S&P 500 is up like or whatever you want to do. James Grant: But gold isn't meant to be
a stock. It's inert. It is non-yielding. Consuelo Mack: Is it meant to be an investment in
your point of view or it's just a store of value? James Grant: I think it's a store of value. But, one hopes it really goes up like a rocket.
I own, for me, enough of it. A lot of it, enough. And it's deeply frustrating that
of all the commodities that one could own, gold is the least responsive to this
monetary problem. It's inexplicable to me. Consuelo Mack: Okay, it is inexplicable. I was
just going to say, is there any rationale for it? It's just the way it is in recent history, because
prior to this, it would have been going up. James Grant: It's just what is I mean, I think
some of the oxygen in the room of gold has been stolen by the cryptocurrencies, the NFTs. There
are other speculative play things that people, I think, are banking on to protect them
against a debauchery of the currency. I think we're disappointed in that. I think
cryptocurrencies are not for the ages. If only because there's going to be a
better cryptocurrency than the one you own. Consuelo Mack: It just hasn't been invented yet. James Grant: Well, cryptocurrency is
technology. However, clever are the ones now in circulation, you know, there's
going to be something more clever. However, gold is not going to
be improved upon as an asset. Consuelo Mack: What do we do as investors? How do
we protect ourselves as investors or counter this? James Grant: I'm going to give you a
couple of thoughts and a couple of tickers. One ticker is INFL, which is
a very well-considered ETF by the Horizons kinetic people. And it is,
as the ticker suggests, it's meant to be a collection of equities that will do well because
they have pricing power in a time of inflation. Consuelo Mack: Right. Formal name
is inflation beneficiaries ETF. James Grant: Correct. Consuelo Mack: Right. James Grant: And the other
ticker is PFIX, which is -- Consuelo Mack: Simplify interest rate hedge ETF. James Grant: Thank you, Consuelo. Yes. Consuelo Mack: One Investment for a long
term diversified portfolio that would help us in a time like this where
we're seeing inflation pick up. James Grant: I pick as my one and only portfolio item for a time of inflation. I pick
this underperforming work-at-home, lazybones person called gold, which has refused to perform
as it ought, but I have every confidence it will. It is an investment in monetary disorder.
I think of it that way more than as an inflation hedge. It is investment and
monetary disorder of which we have a lot. Consuelo Mack: And final question
for you, Jim, and that is you told me on the phone recently that that one should
invest in something you don't believe in. James Grant: This is 50 years
of experience talking, Consuelo. Of course, it's a funny way, I hope, of expressing
the imperative doctrine of diversification. I look back on the things that I knew so well,
wouldn't work or didn't belong in any thoughtful person's portfolio. And lo and behold, many
of them did just fine, including bonds. Over the past 40 years, I have been
mostly a believer in other things. So older, certainly wiser is, I guess, a matter
for others to determine, but humbler, I hope, after all these years. And my expression
of my humility before Mr. Market is to own something you think is not going to work. Consuelo Mack: Thank you. James
Grant. Thanks, Jim, for joining us. James Grant: You're welcome.
Consuelo, I thank you. [Music] Consuelo Mack: At the close of every WEALTHTRACK,
we try to give you one suggestion to help you build and protect your wealth over the long
term. This week's Action Point is read Jim grants Money of the Mind: Borrowing and Lending
in America from the Civil War to Michael Milken. First published in 1992 is a history of how
two long running trends the democratization of credit and the socialization of risk converged
in the 1980s to create one of America's greatest speculative booms. As Ron Chernow wrote in his
Wall Street Journal review of Money of the Mind, “It is a brilliantly eccentric,
kaleidoscopic tour of our credit lunacy. A fitting epitaph to the credit binge of the 80s. Unfortunately, we are living with the legacy
of that credit lunacy today, magnified many times over. One can only hope that understanding
how we got here might help us find a way out.” I will also add that reading anything Jim Grant
writes, is an intellectual and literary treat. Well, next week, in a WEALTHTRACK exclusive, great
investor and small cap stock pioneer Chuck Royce discusses the historic opportunities
available in this underrated asset class. In the meantime, in this week's
extra on www.WEALTHTRACK.com, Jim Grant discusses his latest literary project, a deep dive into 18th century finance through
the lives of two brilliant eighteenth century orators -- Edmund Burke and Charles James
Fox, who were also perennially broke. Please follow us on Facebook,
Twitter and our YouTube channel. Thank you for spending time with
us, no matter what the format. Enjoy your weekend and make the week ahead
a healthy, profitable and productive one.
