Announcer: You're listening to "Ask the Expert" on Sprott Money News.
Craig: Well, greetings once again from Sprott Money News and sprottmoney.com. This is your "Ask the Expert" segment for May 2018. I'm your host, Craig Hemke, and joining us this month is Jim Grant. Many of you will recognize Jim. He is the editor and founder of the very popular Grant's Interest Rate Observer, which actually founded back in 1983. He's an author, a columnist and a frequent guest on financial television and you can find his work at his website, grantspub.com, and I certainly encourage everybody to check that out and check out a subscription because it's extraordinarily valuable. There's a reason Jim's been doing this as long as he has. So, Jim, thank you so much for taking some time with us.
Jim: Craig, you are entirely welcome.
Craig: All right, my friend, this is going to be a fun format, I think. Again, at Sprott Money News, we solicit questions from our customers over the course of the month once we have these interviews scheduled and for you, we have seven separate questions. They may dance around a little bit, but I think you'll enjoy answering them. So, if you don't mind, I think I'll just dive right in.
Jim: Yes, well, you do that, Craig, and there are seven questions, I know, I'll see if I have three or four answers, but do proceed.
Craig: You got it. First and foremost, let's start with the U.S. dollar. That's something that a lot of precious metals investors follow because of the inverse correlation often between gold prices and the value of the dollar. We've had quite a rally here in the last month or so, Jim. There's just a major surge in the dollar at least as measured by the dollar index. What do you think? Is this the start of a new uptrend in the dollar to new multi-year highs or is just simply a bounce within a downtrend?
Jim: That's easy. I don't know. I can observe, perhaps a little bit obviously, that the dollar is among the cleaner dirty shirts in the laundry that is the fiat currency world. It outyields the Yen and it outyields, of course, the Euro. It's the Coca-Cola of monetary brands. It's not such a bad piece of paper if you're comparing it to other pieces of paper. As to whether this is the start of something very big, I surely don't know that. Yeah, so once you say you don't know, I suppose it's time to shut up. Please ask number two, Craig.
Craig: Well, you know what, I want to be... Selfishly, I want to pick your brain on something, though, as a follow-up question because I know you're a historian and a market historian. I reference a lot of the time when I give interviews about how there's really nobody left alive that remembers a time when the dollar wasn't the world's reserve currency, but really it was only 70 years ago. This ability to be the world's reserve currency, you know, as John Connolly said, it was an exorbitant privilege. It's transitory.
Jim: [inaudible 00:03:08] perhaps Jacques Rueff, any case. Yeah, well the reserve currency idea, as you know, the dollar is the official currency designated for reserve purposes. That if you want to hold money in your so-called treasury, a treasury without treasure by the way, but if you want to hold money in your treasury to defend your currency against unwanted depreciation, chances are that the currency of choice will be the dollar. That is it's official, exalted, anointed status.
Now, the world's authorities can anoint and exalt, but ultimately the marketplace is the judge and the dollar's market share as it were and the reserve world has been dwindling in recent years. It was as high as, what? Sixty-eight percent a few years ago, now it's at 64, I think. It is meeting some competition from the Chinese Renminbi, from the Euro, from the...not the Yen so much.
But the reserve currency is in part an official appointment, that status is, but also, its habit. You know, people transact habitually and the Pound sterling preceded the dollar as the world's reserve currency and its role dwindled even into the 1960s, long after Britain had relinquished its economic power and military power that was responsible for the elevation of the pound in the first place. So if the dollar is going to go the way of other pieces of paper, I think that the travel will be long and there's nothing dramatic, I think, is likely to happen with respect to the dollar, but it has been losing caste and maybe it will continue in this context of being the cleanest dirty shirt.
Craig: Sure. Well, I think that's an excellent segue to the second question, actually. As an interest rate expert, you know that a lot of pricing of bonds is a function of future inflation and since 2009, at least by official measures, price inflation in the U.S. has remained subdued. So, do you expect a surge in inflation soon and if so, what would be the cause?
Jim: Well, you know, the question is very well posed because the cause of the great inflation of the '70s is even now disputed. If you look back into the, for example, 1960s, the era that immediately preceded the great inflation that began, let us call it, in 1967 or '68 and lasted into the late '70s into the early '80s, that inflation was preceded by a period of startling and most complacency-inducing price stability.
From 1960 through about '64, the CPI in the United States rose scarcely by 2%, in some years, less than 2% and people thought they had solved the problem. The Keynesian economists of the day thought they had finally found the philosopher's stone. What followed that period of almost preternatural common prices was, of course, the great, great disruption that we now know as the inflation of the '70s, all of which is by way of observing that what precedes an inflation problem is not the obvious signs of a coming inflation problem, but rather, the apparent conquest of the inflation problem by central banks.
Now, today's central banks are actually trying to induce inflation. That is their perceived mission or their stated mission. So you ask whether there's going to be a new inflation. I think there will be. I can't tell you when, but I think that the monetary tinder is in place for quite a bonfire.
Craig: Yeah, yeah. Did you watch that velocity of money much, Jim? Do you pay much attention to that?
Jim: Oh, yes, yes. The velocity is still on the comatose side. The rate of turnover of dollar bills is still subdued. But, you know, people, when they lose confidence in a currency, and that is the final and ultimate source of inflation, it's the loss of faith in the currency that's meant to hold stable value. When people lose confidence, they can lose it kind of quickly and without an evident crystallizing event.
So in short, Craig, my view on inflation as informed by the surprise appearance of the inflation of the '70s in the '60s, my view is that you cannot be dogmatic on when something is going to start. There's when an inflation is going to start, but you have to be aware that it can seemingly come from nowhere. I think that we have enough plausible causes of inflation in place so that one ought to be respectful of the possibilities of real inflation probably emerging. How soon? We don't know.
Craig: Right. Okay, let's shift gears a little bit, Jim. The stock market, as you know, has been on really a historic run since those lows in early 2009. I mean, this is probably a fool's errand trying to predict the stock market correction, but that's what the question is. Do you foresee this stuff?
Jim: Well, I do have practice in predicting stock market corrections.
Craig: Well, let's give it a try.
Jim: I mean, as they say sometimes, let's not overthink this. So, what we have is a stock market sustained for many years by 0% interest rates or lower in some parts of the world by a determined central bank action to raise up asset prices and by a recovery of a very, very deep and frightening recession. So, what we have today, 8 or 9 or 10 years into this, is rising interest rates. Central banks, at least the Federal Reserve reversing, of course, they're promising to. We have valuations very high and those valuations in some measure, some important measure have been sustained by the ease of credit, which ease might be a thing of the past. So, for all those reasons, I think that the stock market presents rather more risk than reward.
Craig: All right, let's move on to question four then, and this is obviously a rather pertinent question in 2018. For how long will the Fed continue hiking the fed funds rate and does your forecast here make you a bond market bearer?
Jim: The first mystery first. When will the Fed cease and desist and what will cause it to do so? You know, Mike Tyson uttered this famous line which people quote often without apparent relevance to what preceded the quotation, but now, at last, there is a reason to quote Mike Tyson's line. That is, "Everyone's got a plan till it gets hit." And the Fed has a plan. It wants to normalize interest rates and its talking about raising it's still little, tiny Fed funds rate three or perhaps four times this year. More, some say. The Fed wants us to know that the stock market will not stand in its way. Well, that is fine as long as the stock market is trending up or sideways, but my suspicion and indeed my conviction or a little more humbly, my guess, is that the Fed is going to change course when things get a little scary, as well they might.
So, you ask about being a bond bearer. I think, underscore think, which is to say guess, that the bond market put in its lows in yield and highs in price on the fifth day of July of 2016, I believe. 2016, I think that was the day.
Jim: That was, I think, the Treasury's 10-year security changed hands at, like, 130 something. 136 basis points, not much at all. Something like $14 trillion of sovereign debt was quoted at nominal yields of less than 0 and the world was positively enraptured with bonds and terrified of being left without them. That was, I think, an emotional blow-off and evaluation blow-off and the bull market began in the fall of 1981. So yields went from 15% on long data treasury, something like a little less than 3%. That was that 35-year odyssey. So yes, I am bearish on bonds, especially I am bearish on corporate securities that are spread relatively tight against treasuries.
Now, treasuries do offer at least the rhetorical promise of absolute safety. We can talk about that in a moment, but they do mostly constitute a port in a storm, especially a stock market storm. So, you can always say something for treasuries, but I think you can say much less indeed, almost nothing at all for corporate securities at a time, let us say, of rising rates and let us also say of possible deteriorating credit quality when they are priced as these corporate securities are today. So, I'm especially wary of corporate debt.
Craig: Well, I think that's an interesting segue to the fifth question now because this is the only question that deals with gold, which is obviously of interest to Sprott Money and to most folks listening. I know you've spoken about gold highly from time to time. Do you have a forecast for gold prices over the next few years? Would gold fall if the stock market corrects? I'm going to add one other thought here because you just talked about interest rates. A lot of folks out there are now talking about gold as a measure or a declining and falling versus real interest rates. So let's put that on there as a third part of the question.
Jim: Well, it is possible to correlate the price of gold at least over the short-term with any number of things. People do it with respect to the dollar. The higher the dollar, the lower the gold price, they say. The higher real interest rates, the lower the gold price, they say. That there's certainly some logic in both of those contentions. My approach to the price of gold is a little bit different and I'm afraid much less helpful on the great question of timing.
My approach is that the price of gold is reciprocal of the world's faith in the institution of managed currencies and of the judgment of the central bankers. So, the greater the faith, the lower the price. The less the faith, the higher the price. In my opinion, faith in the institution of central banking, as it's now a practice, is unwarranted. So, I am forever expecting a higher price of gold and I'm frequently disappointed in that expectation.
But, my thinking, I guess, is it comes across as almost geological in its time sensitivity. You know, I own a fair amount of gold and I own it a little bit with somewhat greater confidence when the value is going up, I guess we all do and hold a little more trepidation when the value is going down, but I keep holding it. And I keep holding it because I take a very long view and a very critical view of monetary affairs and I believe that this moment in our monetary history will go down as a troubled one and that the ultimate beneficiary of this deeply embedded trouble in money and credit, the ultimate beneficiary in financial terms, will be the quoted price of gold.
Craig: Just a quick follow-up, Jim. I'm just curious to get your opinion. You know, the history of the London gold pool is well documented and the central bank willingness to feed physical gold to help maintain that $35 price through the '60s. Do you think central bankers look at it the same way you do, that gold's a reflection of confidence in them? Therefore, do you think it's possible that they like to still feed gold to the market?
Jim: I once had the opportunity to ask Paul Volcker about gold and he said that he was always rooting for it to go down because he viewed it, he viewed a rise in the price of gold as an indictment of his regime at the Fed. He was very mindful of this. I don't know. I think that the present day central bankers just don't care about it. I don't think they have any particular knowledge of history. I mean, Ben Bernanke confessed as much, certainly demonstrated as much. Janet Yellen, I think, is much or more so. Mario Draghi, is he a student of that? No, I don't think so. Mervyn King is much more informed on these things, but I think the principal central bankers of the world are technocrats. They don't know or really care that much about what preceded the regime of post-Bretton Woods in 1971, '72 and '73 after that period.
So, you ask whether the central banks are feeding gold to the market to hold its price. I doubt it. I just don't think they care that much. From their point of view, the risk of being uncovered or exposed in this nefarious dealing would be much greater than the benefit received. What do they care over the price of gold, I think, I think?
Craig: All right, let's move on to question six, and this, kind of, gets back to the bond market and I'll be curious to hear your answer on this one. It's just simply this, are higher U.S. loan rates being driven by a strong U.S. economy and expected inflation or instead, is it also a reflection of deteriorating U.S. credit quality? I would just add, I mean, it's an oversimplification to look at it this way, but every 1% higher in interest rates essentially raises the debt carry cost of the U.S. government by a couple of hundred billion dollars. So, do higher interest rates reflect, I guess, that credit servicing problem?
Jim: Yeah, I think it's a little less than a couple of hundred. I think it's a hundred and forty-something, but anyways, your point's well taken. You know, we have just produced at Grant's, we have produced a model prospectus, a model bond prospectus for the treasury. We've done this, I think, 6 times since we got started doing it in 1985. This is just out as we speak. What we try to do is present the government's finances as they would have to be presented if the government were a filing end of the Securities Act in 1933.
So we have a dozen pages of risk factors that enumerate some of the things that you allude to such as the explosion in entitlement spending and the inherent conflict within a government that both issues debt and also runs the central bank that attempts to depreciate the currency by 2% a year. What we have observed over the course of 30-odd years of doing this is that the objective credit quality of the government as measured in, for example, the, I don't know, interest expense as a percentage of receipts or gross debt or debt in the hands of the public. These objective measures of credit quality seem not to count in the calculus of the government's borrowing cost because there's been a 35-year bond bull market which is overpowered by considerations of physical credit, creditworthiness.
But let us say that the market turned in 2016 and that we now are embarked on what might prove to be a generation-long bear market in bonds. These cycles in bonds do tend to work in generation spans. In that case, what we would see, I believe, is a much greater attention to the credit metrics of the government. People would say... You try to explain, try to understand why interest rates are going up, they say, "Oh, yeah, the Treasury is borrowing a lot more." And the Treasury is borrowing more in the Federal Reserve and spitting out upwards of $600 billion as it plans to do per annum in securities off of its massive portfolio. There is much too much debt in the market and, of course, prices will fall and the rates will rise. So, that just might become the focus. The credit quality to which you allude which has seemingly been irrelevant lo these three and a half decades, this might now suddenly be about to become relevant.
Craig: All right, Jim, just one last question. I think this is a fun one to wrap up on. I've seen you interviewed countless occasions and sometimes people will say, "Okay, Jim, if we made you the head of the Fed tomorrow, what would you do?" Your standard response is, "I'd resign," I think, and I can't blame you for that. But hey, let's just, for fun, let's just say President Hemke appoints you to head the Fed and you get in that job and you cannot resign, what policies would you hope to enact? What would you change?
Jim: Well, what I would try to do first of all is to help to change the public's perception of what the Fed can do and should do. I would announce that the Fed is now out of the asset manipulation business and that it is out of the interest rate suppression business, I would say in my first well-received speech. I would say that interest rates are prices and ought to be determined in the marketplace, discovered, not imposed and that we are going to move in that direction. And that we would also like to move in the direction of redefining the dollar as a certain weight of something or other and I would nominate gold because it is the monetary metal par excellence and the United States would welcome partners worldwide in reinstituting the regime of sound money and of fixed exchange rates all to the end of peace and prosperity. And let's all get together and plan this out. That's the first speech. Now, in my impeachment hearings, I would get around me the finest lawyers available in Washington. That's my second idea as the Fed Chairman.
Craig: All right, would you allow the audit that Ron and Rand Paul always seem to be asking for?
Jim: Oh, I would insist on it. Sure. We're going to have a little sunshine in the government from now on.
Craig: Yeah, yeah, I hear you. Jim, I got to tell you, thank you so much for your time. This has been extraordinarily insightful.
Jim: Well, Craig, it's been delightful and next time, I'm going to have a few answers.
Craig: All right. Again, we've been speaking with Jim Grant, the editor and founder of Grant's Interest Rate Observer. You can find his work at grantspub.com and I encourage everybody to check it out. Jim, thank you so much for your time today.
Jim: Oh, you're welcome. Okay, bye, Craig.
Craig: And from all of us here at Sprott Money News and sprottmoney.com, thanks for listening, we'll talk to you again next month.