If you think interest rates seem high right now, you might be operating with too short of a perspective. For a longer-term perspective, you'd want to talk to someone like Jim Grant. On this episode of the Odd Lots podcast, the founder and editor of Grant's Interest Rate Observer and a long-time financial commentator talks to us about why we're at the beginning of a longer-term trend of higher rates that could last decades. He argues that investors will struggle to shake off years of "buy the dip" behavior, a ZIRP mentality, and a misplaced faith in the Federal Reserve. We also discuss what it means for market behavior today. This transcript has been lightly edited for clarity.
Key insights from the pod:
It's an exciting time to watch interest rates again — 3:01
The dogmatism of the Fed — 4:50
Why the Fed's tools have gotten rusty — 5:31
Why investors are so excited by private credit — 7:47
What Nvidia says about today's market — 11:47
How Jim thinks of his own career — 13:35
When is the tipping point? — 17:57
What is going through the mind of today's speculators? — 21:20
Why interest rates could be rising for years and years — 23:39
Can Wall Street adapt to rising rates? — 29:09
Will the public lose faith in the Fed? — 33:37
How to make money as a contrarian — 37:28
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Tracy Alloway: (00:10)
Hello and welcome to another episode of the Odd Lots podcast. I'm Tracy Alloway.
Joe Weisenthal: (00:14)
And I'm Joe Weisenthal.
Tracy: (00:16)
Joe, did you see the JOLTS number that just came out?
Joe: (00:18)
We are recording this May 31st, 2023. I did. Job openings are back up. You know, that’s the thing. They keep thinking, “Oh, the labor market's gonna cool, it's gonna cool.” But here we are, over 10 million job openings again.
Tracy: (00:30)
Right. So job openings far exceeded, I think, any analyst estimate — 10 million openings for the last month. And I guess the question is, the market seems to be of two minds here, right? You have a lot of people who seem to be talking about the inevitability of recession and yet you have the data that's still coming in stronger than a lot of people are expecting.
And of course, you know, those two things are related because if data keeps coming in stronger than expected then maybe inflation doesn't start to go down and the Fed has to hike even more and it pushes the economy into recession. But it does feel like not only is there a lot of doubt at the moment, but we're sort of heading in two possible polar opposite directions.
Joe: (01:12)
Well, the thing that I keep coming back to as striking is, if you told someone, you know, at the beginning of January, 2022, you know, when rates were at zero, that by spring 2023 we'd be at 5.25% on the Fed funds rate, then everyone’s like you know, the market would've crashed, we'd be in recession, etc. And yet here we are with more than 10 million job openings.
And something that we've talked a lot about is, you know, the entire 2010s was sluggish growth. And everyone's like, “Oh this is the pick-up, this is when inflation is gonna come back.” And it doesn't happen. And so far this decade it feels like, okay, this is finally when inflation is gonna roll over, this is when the recession is gonna happen, etc. And these expectations keep getting kicked forward.
Tracy: (01:52)
Absolutely. And I'm glad you mentioned interest rates just then. The implication is kind of, we've had years of people warning about what's gonna happen when interest rates rise. Is it going to lead to an explosion in interest rate costs and things like that? And, you know, we have seen some bankruptcies, but we're still sort of at this inflection point, it feels like.
So I'm very pleased to say that we have the perfect guest for this episode. We are going to be speaking with the man, the myth, the legend, Jim Grant, the founder and editor of Grant's Interest Rate Observer, and a longtime commenter of financial markets. I've been a fan of his work for many years, so I'm so glad we can finally have him on the show. Jim, thank you for coming on.
Jim Grant: (02:34)
Tracy, it is lovely to be here. And yes, interest rates are a thing again. I began to doubt the efficacy of my business model...
Joe: (02:41)
People are observing. People want interest rates observed.
Jim: (02:44)
Yes, it is a good time for observation.
Tracy: (02:47)
Well, maybe that's a good starting place, but how would you characterize the current period in markets versus, you know, the trajectory of history You've been through and written about many interest rate cycles at this point.
Jim: (03:01)
Well, [in the] first place I would call it good copy.
Joe: (03:05)
This is what we like. It doesn't matter up or down, just give us some good copy.
Jim: (03:08)
Yeah. We don't want peace and quiet. Well, there are so many singular features. And dogmatism has been, I think, I hope has been expunged from the conversation. And it's hard to dogmatize after 2020, 2021, etc. What is new and different is, for example, interest rates have gone from nothing to 5+ on the short end of the yield curve. And wouldn't you suppose that the home builders would've taken a big hit. But instead, home builders are right behind Nvidia as the stocks. And you would think that they produced computer chips rather than 2x4s.
But the home builders made new highs recently. And you know why? Because rates have kind of put interest rate handcuffs on people who are in possession of one of these sweet mortgages, beginning with the numbers two or three or four. And I think most of the homeowners now that have loans have something less than five. So people aren't moving and there's no supply. I exaggerate slightly, but there's little supply and the home builders are hot footing it into that gap. And they are coining money with huge margins and great perplexity all around .
Joe: (04:23)
So you're speaking our language on multiple levels. You mentioned semiconductors with Nvidia. 2x4s. We've talked lumber, we've talked home building. So what does that say then about our efforts to fight inflation? You know, we think of housing as like the ultimate rate sensitive sector, and yet here we have home builders close to all time highs despite the surge. What does that say about, I don't know, perhaps the Fed's toolkit in fighting this kind of inflation?
Jim: (04:50)
The Fed only about two weeks ago was propagating it. All the central banks of the world for years and years were bemoaning the fact they could not hit their 2% — arbitrary mind you — the arbitrary 2% inflation target. And the Fed as recently as the Jackson Hole speech of what, 2020, that remote Jackson Hole conference, Chairman Powell said, you know, we are going to search for a flexible inflation target, and if it's too low, we will overshoot and thereby bring the average over the cycles up to more than 2%. Now that was, it seems to me, that was kicking sand in the face of the fates.
Joe: (05:30)
Right.
Jim: (05:31)
And so there's a bureaucratic dogmatism in the Fed. They've got these algebraic models, my goodness, how formidable they look on a blackboard, but they don't actually function very well so far as the future's concerned. And the Fed was in fact, dogmatic through 2021 into 2022 buying mortgages [A] recently, I think as March, 2022. So you asked about their inflation fighting tools? They're rusty.
Tracy: (06:00)
Well, just on that note, I mean, walk us through why haven't the interest rate increases fed into the real economy more? Why are you not seeing house prices go down? Why are you not seeing the much anticipated wave of bankruptcies that people were warning about for, you know, many, many years after the 2008 financial crisis?
Jim: (06:20)
Well, I think house prices have in fact gone down. There’s this phrase “existing house prices.” That is the ones that are not imaginary. So existing house prices are down, new house prices are down from their peaks, you know, 8%, 10% of memory serves. But the point is well taken, Tracy, that, you know, the phrase, I think something will break, right?
And I was of the view that try as Jay Powell might [to] emulate Paul Volcker, Mr. Powell is not working with Paul Volcker’s economy. There is much more debt, therefore much more fragility.
You know, people are head over heels over private credit. They contend that this is a not quite Nvidia-quality breakthrough in the history of finance. But it's up there. And, but you know, private credit is a manifestation of the imperative to build leverage -- whether it's on the federal level or the corporate level, not quite so much, in recent years, on the individual level. So there's a lot of leverage. And I would say Tracy with respect to the paradox of nothing breaking much yet, just be patient. I expected it might.
Tracy: (07:27)
It’s coming? Where do you see vulnerabilities? You mentioned fragilites. Where are they?
Jim: (07:30)
Private equity is one. I think private credit will be shown to be rather oversold as a breakthrough. I don't think it's any such thing.
Joe: (07:41)
Actually, how do people think about it? Why do people think that there's something special about private credit?
Jim: (07:47)
Well, I think the story goes that the vendors of private, the lenders of private credit, are more flexible. They have commitments by their limited partners who supply funds. They are not constrained by banking regulations. They are kind of a new breed, so the story goes. But you know, they, they are lending to an important extent to software companies, which famously lack GAAP profitability.
They are lending to those very same people that the public credit markets are lending to, but they're doing it at a somewhat cheaper rate. They're not doing it at a rated basis. So Moody's is not getting the ratings business. I don’t know, the whole private credit business sounds to me as if it were the same wine in slightly more presentable bottles.
Tracy: (08:37)
Just on this topic, there's a line that you wrote many years ago now, and it kind of lives for free in my head. And it's slightly random, but it's basically, “In Valeant a financialized age has produced a financialized pharma company.” And I used to think about that quite a lot in the context of Valeant, of course. You know, they borrowed a lot from markets cheaply. They bought a lot of companies. They used interesting accounting techniques such as add-backs to boost their valuation so that they could keep borrowing. And I wonder how much that type of financialization, in your opinion, is reflected across the market and across the economy, not just a Valeant-specific type thing.
Jim: (09:20)
Well, I would say that it is rather endemic. I guess we ought to define it. What I mean by it, Tracy, is the finance for the sake of finance — not for the sake of making a better product, but finance for the sake of making money through structures, through fees and the like. That's financialization.
And you see it again in private equity. There's this thing called add-backs. Add-backs are a form of sly manipulation of cost structure. So you do a deal, you buy a company and, you say “we will lever it,” meaning we will encumber it with debt to the extent of six and a half times EBITDA. That's a non-GAAP measure of earnings. And, and the reason it's 6.5 and not 9.5 is because we project savings through the great managerial improvements that private equity invariably introduces...
Tracy: (10:18)
Synergies! Synergies everywhere!
Jim: (10:20)
Yeah. To its portfolio companies. And don't you know that S&P does an annual add-back study. That's the age in which we live. There is an add-back study from, that you can wait for every year. And it shows that most of these promised savings, Tracy, don't — don't be shocked — don't materialize. But the fees surrounding them are paid. So that's an example of one micro example of financializations. And I think it's all over the place too.
Joe: (11:03)
Since you mentioned Nvidia twice already. I feel like the Nvidia chart would make a lot of sense to me in the year 2021 or maybe 2018, 2019, you know, during the sort of ZIRP heyday when we associated low interest rates with booming tech stocks. But here we have the chart, it's not ZIRP anymore.
We're at five and a quarter percent. And yet that hasn't extinguished the sort of animal spirits of the market to pile into some really hot area because, you know, AI is really exciting. What does that say about some of our assumptions about the relationships between investment and animal spirits and speculation and rates when we see this sort of activity at a time of 5.25% interest rates?
Jim: (11:47)
You know, the wonderful thing about financial markets is that we keep on stepping on the same rake. In science, you know, progress is cumulative. You stand on the shoulders are giants, but financial history is invariably cyclical and recurrent, which helps a lot if you can recognize patterns. Scott Mcnealy, who's the CEO of Sun Microsystems, gave that terrific little speech, I guess on Twitter maybe. It was an exasperated and rueful expression. It was kind of a postmortem of the dotcom bubble, which now is so deep in the historical myths. But Sun was trading at 10 times earnings. And Mr Mcnealy said “what do you have to do?” ...
Joe: (12:28)
No, 10 times revenue, right?
Jim: (12:29)
Oh sorry, revenue. Of course.
Joe: (12:31)
Sorry I didn’t mean, but I think it's important to understand.
Jim: (12:33)
No, that’s the laugh line. Darn! So what he would have to do, what you have to break even with 10 times revenue. Well, over the course of 10 years, I would have to send you every single dollar. So no more R&D, no more salaries for the employees, no taxes, oops, no taxes, etc. So he went through this exercise and he said, at the end he said “why did you pay 10 times revenues?” Okay? And Nvidia is like 35 times revenue. So that's 35 years of...
Joe: (13:03)
No costs, no employees. No CapEx. No R&D, no taxes.
Jim: (13:08)
I read somewhere that Nvidia has introduced AI, which is tantamount — in fact equal to — tantamount to the invention of fire. That's a new fire.
Joe: (13:19)
What's the TAM on that? It's gotta be huge.
Tracy: (13:22)
That's always the warning sign, right? TAM? When people start talking about total addressable market size?
I have a slightly personal question, but I've always wondered this. Do you consider yourself more of a journalist or more of a financial analyst?
Jim: (13:35)
Journalist.
Tracy: (13:36)
Journalist? And how does that influence your work?
Jim: (13:38)
Yeah, I hired Evan Lorenz. He's a great financial analyst.
Tracy: (13:41)
He's great. He's very good. But how does that inform your own work?
Jim: (13:46)
Uh, Evan?! Well, I started as not quite a one man band. I was never exactly a one man band. This is our 40th year. But for many a year, there was no Evan, there was often someone to lend a hand. Yeah. There was a lot of help. I have gravitated to journalism, I think more than the really deep-diving financial analysis. I'm interested in history as well. Have read a lot, written some.
Tracy: (14:16)
You wrote a book on Bagehot recently, right?
Jim: (14:19)
Yes, I did. Walter Bagehot is kind of the muse of contemporary central banking. They invoke his dictum about “in a crisis” they will say, the contemporary central banker, will say “lend freely to everybody,” which is a very much a paraphrase of Bagehot: “lend at a high rate against suitable banking collateral to solve institutions, etc.”
Joe: (14:47)
I just want to say, I thought you must have been exaggerating when you said “35 times revenue.” I was like, that cannot be right. It can't be 30x revenue, but no fiscal year 2024, the estimate for Nvidia revenue is $40 billion. It's a trillion dollar company. And so yeah, we're basically there.
Jim: (15:04)
It looks like a typo. We published it last night and I was like "please, this can't be...”
Joe: (15:09)
Even looking at fiscal year 2027, currently on the Bloomberg, it's only at $77 billion. So even if you go out to 2027, you're still like at 15X 2027 or 14X 2027 in revenue...
Jim: (15:22)
Bloomberg, which can get anyone on the phone, ought to call up Scott McNeely and say, “oh, what now?”
Joe: (15:26)
Let's do that. Let's do that. That's a really good idea. Scott's really, those earnings calls back in the day were really fun.
Can I ask a [different] question? You know, you mentioned dogma, you mentioned the Fed's rusty inflation fighting tools, which, you know, maybe understandably because for the previous decade or really even longer, maybe the impulse was reflation and “why are we missing on the downside,” etc. What did that period teach you as a historian of financial markets, a student and someone who's like... what did the period of 2009 through 2020 in which we had large deficits, we had this exploding size of the Fed's balance sheet, and yet this sort of inability to generate inflation. What was your sort of, looking back on that decade? What is it the implication?
Jim: (16:11)
Well, it was very humbling for me. What I took away from it is that the inevitable is always certain but not always punctual. I look back on some of my work there and I was rather impatient for the inevitable difficulties and crises attending upon this credit creation jag.
I thought certainly it was gonna happen like Tuesday or so. So it's like the elapsed time between the first signs of house prices going way above trend on the one hand and the onset of the housing-related credit difficulties of 2007, 2008 and 2009, that period of six years was approximately 20 years in journalistic time if you were a little bit too insistent upon.
Tracy: (16:58)
Well, just on this point, let me ask a sort of devil's advocate question because I had, you know, a similar trajectory sort of, I wouldn't compare myself to you obviously, but, you know, post 2008, I wrote a lot about excesses in the corporate bond market, and it seemed very clear to me that eventually this would blow up. It didn't really, and you know, we could argue that maybe the time is coming for some of those excesses to get flushed out of the market, but it does feel like the solution to a lot of financialization is more financialization — or at least it has been so far.
So for instance, with corporate bonds, when there was stress in the market, the central bank comes in, props up the corporate bond market through the bond buying program. Why can't that continue forever? And what is the tipping point at which financial solutions to financial problems is no longer viable?
Jim: (17:57)
A tipping point was six years ago.
Tracy: (18:00)
That's very specific.
Tracy: (18:01)
No, my impatient clock. It was a long time ago, but it did not tip. So why can't it go on forever, I don’t know? They're always these excesses that do crop up. They are met with additional stimulus intervention, manipulation. And still we go on. Who was it who said there is a deal of ruin in a country? I guess it was Adam Smith.
And there's a great deal of ruin, so to speak, in finance and manipulated finance. And one of the singularities of the present time is the American position in international finance. You know, this country emits the reserve currency, which means that we consume much more than we produce. We finance the difference with dollar bills that only we can lawfully print at a most reasonable price of like nothing.
Jim: (18:50)
And we remit the dollars to our creditors, mainly in Asia, say, and those dollars don't leave the country because they come back in the shape of Treasuries and mortgages purchased for the portfolio interests of our accreditors. So that is kind of a new thing in the long historical sweep. It's not so new in terms of years, but in terms of phenomena, the reserve currency country being a chronic big debtor, that’s kind of a different thing. Reserve currency country living on the kindness of strangers, so to speak. That’s not exactly writ. The more one learns, the less dogmatic one becomes about timing, certainly
Joe: (19:31)
That actually leads to the exact next question, which is, you know, obviously currently today in 2023, there's yet another round of, “oh, is the dollar gonna lose some its global status?” But we've been hearing that forever, right? We heard that certainly after the great financial crisis, I think, you know, pre-great financial crisis, there was a lot of talk about the euro and we've talked about in the show and, you know, who is the model that flashed euros? This is not a new thing. So when you think about like, okay, like timing is really tough with this stuff. Does it feel new? Does this moment feel different than past times when people had dollar status anxiety?
Jim: (20:08)
Well, some of the rhetoric's the same, you know, I guess by definition the excesses are greater. The US international financial position, which is a piece of data that comes out every year by this time shows a deepening deficit between what we own in other countries, securities and businesses versus what they own of our securities and businesses and other securities and and public securities.
So the deficits deepen, but still so what's the competition? Turkey is mad at us and wants a different currency. Iran, ditto. China and the Russia the same, but I don't see those as strong competitors for an alternative currency. I see gold as a perennial option. Unfortunately, too few people share my enthusiasm for that. I wish, perhaps Bloomberg could...
Joe: (20:59)
It's everyone else who's wrong.
Jim: (20:59)
Perhaps Bloomberg could help along those lines as well.
Tracy: (21:03)
Well just on this note, I mean, we were talking about Nvidia. When you see markets react like that, what do you think is happening there? What is the thought process of an investor who says “I'm gonna buy Nvidia when it's up 40% in three weeks?”
Jim: (21:20)
Well a couple of things. First of all, again, under the heading of you never know, which I have come to embrace as a sound journalistic and life principle. There is a possibility, at this time, it is the invention of fire part two. So one holds mind share for that. I think more likely that this is part of the muscle memory of a generation of 0% interest rates and all you can eat credit.
The great all you can eat credit buffet table was open for business for 10 years. Interest rates fell from 1981 until a couple of, actually a couple of weeks ago. It's called 40 years. So that's a lot of muscle memory. Central banks have intervened predictably until fairly recently when markets shuttered. Look what happened in 2019. You know, the repo market, this obscure recondite thing caught a head cold in September and the Fed resumes QE and said it's not QE. Yeah, it was QE.
So naturally people assume that the upside is the side to be on. It takes a true contrarian, almost a bloody-minded contrarianiess to butt one's head against that. But it's a living. So why do people do it? Because A) because cyclical memories are short and cycles are recurrent, and B) because it has ‘worked’ — that phrase ought to be in quotes.
Joe: (23:06)
It's funny, you talk about like the memory of ZIRP, or the memory of 40 years of declining interest rates. Right before you walked in, Tracy and I were talking about the real estate market, and I've sort of been looking at maybe buying a place, and the one thing you always hear from people is like, “oh, well, rates are high now, but you maybe you'll be able to refinance lower in a few years.”
And every time I hear that, I'm like, I mean, that would be nice, but there's no guarantee of mean reversion and you know, what were they? Like 18% in the 1980s? Could we go back there? Could I see teens Fed fund rates in my life?
Jim: (23:39)
Yes, you could. There's a property about interest rates that I find intriguing — my interest is not widely shared — but here is my reading of the question. The great question of whether rates are mean reverting? So what characterizes interest rate movements is their generation length phasing, not necessarily cycles, but there are phases.
Interest rates fell for the last quarter of the 19th century, rose for the first 20 years of the 20th, fell from 1920, ‘46 rose in ‘46 to ‘81, fell from ‘81 to, call it, 2021. So at each juncture there was some mark of excess, some mark of speculative excess blow-off. Certainly in 1981, you know, a 20%+ funds rate seemed excessive. A 14% yield in 1984 in long bond when the CPI was printing at four or five, that seemed excessive. 10 percentage points of real yield — that seemed a lot.
So I speculate that we are embarked on a long cycle of rising rates. And I say that first of all, for reasons of pattern recognition, there's no theory behind it. But I observe that in 2020 and ‘21, some unimaginably large number of debt securities were priced to yield less than nothing. Bloomberg keeps this particular figure. And I bet still, perhaps you could check me on this, I bet still there's like a hundred billion of bonds priced to yield less than nothing worldwide. But there were $18 trillion, I think at the peak.
he most extraordinary expression of unqualified bullishness on an asset class because it had the name of “bonds” which had been falling in yield, rising in price. So no, it would not surprise me at all if we were embarked on something resembling a generation length bear market in bonds, meaning rising yields and falling prices that would fit the form.
Tracy: (25:33)
You mentioned the idea of embarking on a long cycle of higher rates. Could that happen even with a recession in the states? Because this seems to be the bet that everyone's making, right? That inflation isn't coming down and so the Fed's gonna have to hike and inevitably that will lead to recession and then cuts.
Jim: (25:54)
Yeah. Well, starting in 1958, something strange happened and people at the time remarked on it, which was that in a recession, prices did not fall or subside. And that marked what proved to be the beginning of the age of inflation. So fast forward to the seventies. Seventies is kind of a trite historical marker, you know, it's never going to repeat exactly, but for what it's worth, in the seventies, interest rates did fall and rise as the business cycle changed. But inflation came and rose and subsided in three different phases. It wasn't a straight line. So yeah, we could have a recession and rates pull back and then they resume the rise.
Tracy: (26:38)
So the long-term path would be upwards in terms of interest rates, but not linearly?
Jim: (26:42)
Yeah. So for example, from 1946 to ‘56, the movement up in the long-dated Treasury was 100 basis points — 1%. That was, it went from 2.5% to 3.5% over 10 years. So this is rather glacial. This is kind of geologic. So that's why one can forecast these long cycles with, especially if one is 76 and a half years old, without any anxiety about being laughed at.
Joe: (27:12)
But to your point, I mean, it makes sense. As you mentioned, that 40 year cycle basically through, I don't know, 2000 whatever, it's not like it was only down, I mean, we had up cycles in the eighties and the nineties.
Jim: (27:24)
Oh yes.
Joe: (27:25)
And pre-GFC. It's just that the long-term trend was lower highs each time. And so potentially the idea here is, okay, maybe we do get a cutting cycle in a year, but it's lower lows each time.
Jim: (27:34)
Absolutely. Yeah. So what happened is rates peaked in 1981 and 1984, there was what the technicians call a retest of those highs in yields. And everyone on Wall Street who was anyone was on the side of saying that rates will go back up again. And that long bond did go to 14% in 1984, when inflation was less than I think less than 5%. So I think one of the least appreciated forces in markets or factors as they would say, is simple condition behavior or muscle memory.
Tracy: (28:05)
So just on that note, I was thinking back. I used to have a grandparent who lived through the Great Depression and had food hoarding problems because of this, because she hadn't had a lot of food when she was growing up. And so in her later years when she had access to food, she would buy a lot of it and store it. I'm assuming markets are ill-equipped to deal with this kind of generational shift? You have people, Joe and I certainly, you know, for 40 years have been striving for any sort of return, any sort of yield. We've only recently started earning significant bank interest on our savings accounts.
Jim: (28:45)
Isn’t it pleasant?
Tracy: (28:45)
It's so nice. It's lovely being a rentier. Money for nothing.
Joe: (28:49)
You could probably make some money if we plugged which online banking [you use], but don't do it.
Tracy: (28:56)
I'm not going to.
Joe: (28:56)
Not until they pay us, we're not going to say where.
Jim: (28:58)
Hold out for that.
Tracy: (29:00)
Right. And I'm aware that, you know, the real return is still negative but it's still nice. But how would you expect markets to adapt to this shift?
Jim: (29:09)
Well, if it's slow enough, they could adapt easily. The great shift to higher rates, as I mentioned, took 10 years to get started. I remember my first job on Wall Street, I just got out of the Navy, and I was, before I went to college, I was a clerk on a Wall Street trading desk. And I came home and the New York telephone long-dated sizes, the sexy sixes, they called it. And I told my father this, what everyone says dad, is that these 6% yields are, this is something special and you have to avail yourself.
So I'm not sure where the New York telephones were in the year 1981, but they were not at 6% . So, you have to pace yourself, but there's often plenty of time to adapt. But, you know, there's opportunities in the non-adaptation. In a great bond bear market, all sorts of strange things happen. For example, call protection goes for free because no one expects rates to go back up again. So you can buy call protection without any premium.
Joe: (30:04)
When you look at these long shifts, these multi-decade moves, how much is it about maybe politics or just shifting ideas? And so, you know, I'm thinking, part of the reason, I think, many people would say we had such a powerful and aggressive fiscal response to the Covid shock was the memory of the weak recovery coming out of 2008, 2009. And the sort of years of slow growth. Okay, we're not gonna make this mistake again.
Jim: (30:29)
We’ll make another one!
Joe: (30:29)
Yeah, we're gonna overshoot in a different direction. And so how much, when you look at sort of long shifts and obviously like that era and some of those ideas, some of the supply side ideas from the early eighties, like those are ancient, those are old memories. People forgot and now people have different ideas. And now people talk about state capitalism and public investment. How much do these long cycles sort of correspond with essentially ideas that are in vogue?
Jim: (30:56)
You have to wonder whether the direction of causation, Richard Russell, who's a marvelous technician and thinker about markets, who is no longer with us, he was the author of the epigram “Markets Make Opinions.” And I think there's something to the idea that that phases of economic life, whether they be markets or in 9-5 world of actually producing things, as it were it, that the background music of enterprise kind of conjures ideas. I'm not sure if ideas cause — maybe they might, but these ideas are recurrent. I mean, I'm told that that generation, what comes after Z? A?
Joe: (31:37)
I dunno. It’s whatever my daughter is. I don't know. I gotta find out what that is.
Jim: (31:40)
They're socialists, apparently.
Joe: (31:42)
Yeah, that's actually the case.
Jim: (31:43)
I don't know. I've given you a very poor answer to an excellent question, Joe .
Joe: (31:49)
That's all right.
Tracy: (31:50)
Well, just on the notion of these long-term cycles maybe starting to shift it, it does feel like previous decades were about sort of lower interest rates. And during those previous decades, we basically built the financial system around the assumption that government bonds are the safest thing out there.
Jim: (32:11)
Super safe!
Tracy: (32:12)
Yeah. Government bonds, you know, the yields don't move around that much. And yet in the previous year, we have seen big question marks around the safety of government bonds and the stability of yields, which have resulted in a few things breaking, to your earlier point. We saw troubles at the banks, the Fed reporting an accounting loss on its own balance sheet. What does it mean for the financial system as we move into potentially a higher rate environment or a higher vol environment for rates?
Jim: (32:44)
I think one of the ideas that has sustained markets over the past, call it, generation, is the idea of Federal Reserve competence. The notion that people at the Fed know what they're doing and can make things happen. They are weather makers in finance and they're responsible for the great moderation. So it started with Paul Volcker and his mastery of the inflation problem and then go to…
So I think that the Fed will be revealed as a bunch of well-intended people who are involved in a kind of pseudoscience, and people will wake up one day and say, “yeah, I've noticed that my weather app is accurate for a day or two, but out 10 days, I wouldn't bet my dog's life on it.” And yet we listen patiently, even reverentially to the economists at the Fed to talk about what's gonna happen next month or next year.
They know nothing. I mean, the future is a closed book. A screenwriter named Goldman... Butch Cassidy and the Sundance Kid. He said apropos of Hollywood's forecasting ability, “Nobody knows anything,” said William Goldman. Correct, correct. As to the fashion of future. But the difference is that the Fed thinks it knows something and thought it knew something in 2020 when it was going to try a little harder to produce more inflation.
It thought it knew something in 2021 by insisting that the problem in front of its eyes was transitory, etc. I don't mean to ask too much of them, but I would ask of them the confession that they really don't know. So we will, I think, have that fact. That simple, humble fact presented to us in a way we can't deny.
You know, not so long ago, I mean, I remember it vividly, 1980, ‘81 when you should have been interested in owning these — they had something called Lions and Tigers. These are trade names for zero coupon Treasury securities priced to yield 12, 13, 14, 15% internal compounding. No reinvestment risk for 30 years, seemed like a good investment.
However, such was the burden of accumulated loss and the loathing that people felt towards this unrepaying brutally punitive asset class that was “certificates of confiscation,” was the phrase that bonds acquired. That was people hurling anathemas at the bond market and at the Fed.
And now, did I mention the Fed’s broke? Now it is a hypothetical theoretical insolvency, but to me it is a symbolic, it is a symbolic fact of not a little importance. You know the only thing that looks more like the Silicon Valley Bank balance sheet than Silicon Valley is the Fed's balance sheet, and they earn at two and they pay at five these days.
And every week they lose a little bit more of their capital in the form of a promise to the Treasury to one day make it up. People gloss over this. They say “oh, well, Fed can print money,” but it can't print net worth. Right? So the Fed's not going to go out of business because it is insolvent, unlike some of its charges — the banks, but the fact that it… Shouldn't the Fed, shouldn't it be held to the same accounting and regulatory standards as the private banks? Wouldn't that have forced all the excesses of Zirp and QE?
Tracy: (36:18)
It can set its own stress test, right?
Jim: (36:21)
Perhaps Jamie Dimon could write a stress test for the Fed.
Joe: (36:25)
The ultimate rescue.
Jim: (36:27)
I heard myself going off on rather a sermon. I will stop.
Joe: (36:30)
Not at all. Actually you mentioned how, if you had bought, at some point in the late seventies or early eighties, some of these long-dated zero coupon bonds, they would've done fantastically well over some length of time. Some of the greatest investments ever. But you had to deal with those first few years and maybe you took some serious sustained losses.
And I was thinking about your point about contrarianism — this bedevils everyone in the financial industry — the challenge of well, how do you maintain some sort of out-of-consensus position in a period. Well, there’s multiple things. But A) there’s the psychological battle of like, well, am I wrong? Is the market wrong? B) You want to make money and C) if you're managing someone else's money, you might not have a very long leash to lose money. What is your thinking about that process of you don't know the exact timing of when it's gonna work. Reconciling these challenges?
Jim: (37:28)
Well I have some experience in this. Mine is, you know, journalists don't get margin calls. Friends of mine who do this for a living — that is to say identify something that is not in favor or in phase, research it, gain conviction and hold it in spite of the scorn and the vitriol of those positioned otherwise. That's kind of the game. Journalistically, all you have to do is have a hard shell. If you're doing it in real time with real money, you either have to have a very, very loyal base of limited partners or investors, or be managing your own money. It’s hard. It's wearing. It is not life enhancing. But when it's right, it's really sweet.
Tracy: (38:19)
Yeah, you get to do the victory laps. Well, Jim, on that happy note, we're going to have to leave it there. But thank you so much for coming on Odd Lots. Really appreciate it.
Jim: (38:26)
Well, you are entirely welcome, Tracy. Thank you.
Joe: (38:28)
That was incredible. That was such a treat.
Jim: (38:31)
Thank you.
Joe: (38:32)
We'll have you back on in 20 years and see where interest rate cycle is.
Tracy: (38:55)
Joe, that conversation was really fun.
Joe: (38:57)
That was a lot of fun. I mean, we've both read Jim's stuff for years. It's always educational, always historically fulfilling. It was great getting to talk in person.
Tracy: (39:05)
Also, I love that he can just throw out anecdotes like, “Oh yeah, this one set of bonds from like...”
Joe: (39:10)
Well, that’s the thing, we could've talk for like three or four hours about buying corporate bonds for like, you know, AT&T bonds or New York telephone bonds at 6%. There's so many stories it would be fun to go down with.
Tracy: (39:23)
Absolutely. But the point that stood out to me was that muscle memory idea. And I think what's happened is — it's not just buy the dip because the Fed's gonna do something and save everyone. It's also that I think a lot of people have figured out that momentum is a thing, and even though something looks like a bubble, if you can get out early enough, you can still make money. So instead of running away from bubbles, people kind of run towards them now.
Joe: (39:52)
Absolutely. I also just think that, I mean, I definitely feel these these days, where it's like the meme stock era, the ZIRP era, the FAANG era. It was so recently that it's like, “oh yeah, that's normal.” That little dip that we had in 2022 when people shunned tech, that was the aberration. But yeah, you see Nvidia and AI, you’ve got to go back to that. And then I think this gets back to the rates thing, which is that like 5% or a 6% mortgage feels really high to people after 15 years of whatever, but it's not. It’s not high at all. [Rates] were were much higher throughout the entirety of the nineties, and they were much higher throughout entirely of the eighties. But, you know, an entire generation, their entire potentially home buying lives is basically the ZIRP era.
Tracy: (40:40)
I do wonder if the novelty of earning interest on bank savings is ever going to wear off for me. You know, it's been almost 40 years of not earning anything. And now it's just amazing to get, you know, a few percentage points.
Joe: (40:53)
I'm so poisoned by the last decade. I can't be bothered to like click the buttons to move over money for a couple percent.
Tracy: (40:58)
Oh, Joe, you gotta do it.
Joe: (40:59)
Yeah, no, you can have my money.
Tracy: (41:00)
Money for nothing and negative real returns. It's great! All right. Shall we leave it there?
Joe: (41:06)
Let's leave it there.
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