“Incredibly Stupid” Central Banks Have Created “A Recipe For Disaster” | Dylan Grice (PT1)

“Incredibly Stupid” Central Banks Have Created “A Recipe For Disaster” | Dylan Grice (PT1)

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as the continuing trillions of dollars in central bank intervention distort asset prices ever higher investors are forced to make an uncomfortable choice do they ride this wave and risk being wiped out if it crashes or do they seek safety now but risk being left behind as inflation eats away at their capital widely respected fund manager dylan grice is choosing to stay in the game but like many investors today he hates how dangerous it's become to do so bullish you know implies it's a kind of good i think they're going up i think they're going higher i think you know valuations are going to look even more crazy but i don't think it's a good thing and it's not something that i'm particularly you know happy about you know it scares me a bit actually welcome to wealthyon i'm adam taggart founder of wealththeon welcoming you back for another week of making sense of money and the markets so that you can make better informed decisions about building your wealth now the majority of recent experts we've interviewed on this program have been extremely skeptical of today's record high market valuations and most of them predict a painful market correction lies ahead in the coming months this is why one of the more common comments i receive is can you bring on someone who was a bullish outlook on the markets well absolutely in fact i'll do that right now in this video but as they say be careful what you wish for as his reasons for expecting even higher prices from here aren't happy ones please join me in welcoming fund manager dylan greis to the program dylan is co-founder of calderwood capital and the author of the highly respected macro research publication popular delusions dylan thank you so much for joining us today all the way from the uk uh great to be here thanks for having me adam great well look so many questions for you but i want to i want to start at the top um before introducing any potential biases into this conversation can you just give us a sense of your current assessment of today's global economy in financial markets um hot uh you know i think i mean everywhere you look there's um there's kind of signs of froth you know um i think it doesn't matter which market you look at i'm just about um you know i think spreads are phenomenally tight uh covenants are phenomenally weak um lending attitudes are very accommodative venture valuations are very high private equity deals are very enormous you know et cetera et cetera um so you know we're clearly i think we have very overheated financial markets and um you know these are the kind of markets that um they're kind of fun where they last and they will you know these excesses will um will will kind of have a cost i'm sure about that all right well let's let's continue the uh the the hot temperature related analogies here so um earlier this year you called yourself a reluctant bull um and i i think you did that and correct me if any of this is wrong but you know back then you had said that the markets had become quote unquote incredibly frothy but you felt that you needed to remain bullish because quote the central banks will overcook the markets so uh my question for you given what you just said is uh is the meal crispy enough at this time or do you think that the central banks are going to continue bringing the heat for a while longer no i actually feel that the the risk is still very much on on the right tail um uh i feel that um uh you know the jackson hole um speech that that jerome powell just gave he he i mean he talked about tapering but he also made very clear that interest rates were going to kind of stay at zero until um he said until we reach maximum employment full employment and until inflation is sustainably um higher than two percent right so there's a period of of sustainable inflation greater than two percent so i feel that that's a kind of recipe for for disaster really um and it feels that that's a mistake that has been made you know a number of times a number of times in history and that mistake is that when you when you you run the economy um uh really with it without with a kind of an exclusive focus on on the cpi um and uh you're kind of blind to other signs of okay nobody you know pilots don't fly an airplane just looking at one measure you know you don't drive your car just fixated on one measure i think it's incredibly stupid to run the economy fixated on one measure um and people that have done it in the past when when central banks have done this in the past they've they've ultimately screwed up you know the very first episode of of running an economy far too hot because you were misled by the quiescence of the cpi and was actually the 1920s it was um it was the federal reserve and and that led to the um the bubble in in the late 20s which of course led to the great depression or was one of the triggering events of the great depression it wasn't quite as simple as as as you know as a stock market crash therefore great depression but you know it set in sequence you know a series of mistakes really but the the biggest mistake to my mind was allowing the thing to overheat in the first place and the reason they allowed it over in the first place was because they were just they had the blinkers on they were looking at the cpi and since then you've had um japan in the in the 80s right that was exactly they had exactly the same phenomenon they didn't see that or they were they they turned a blind eye to the overheating in real estate and stock market because inflation was so low so though there's no inflation because the cpi is is is actually quite um quite well behaved so you know there's nothing to worry about of course that was you know catastrophically wrong you know all the asian economies in the late 90s did exactly the same thing alan greenspan did the same thing also in the late 90s with the tech bubble ben bernanke did it a few years later right with the housing bubble and the sub-prime crisis so i think this is kind of a well-trodden path and and when jerome powell says you know i don't have any worry about as long as the cpi is is quiescent uh for me that just sets off alarm bells and so i just feel that this froth is is is just going to build and build and we're probably going to look at we're probably looking at another bubble so that's why it was kind of you know i said it was kind of you know an answer to the question you're are you bullish of risk assets here then you know as i said bullish you know implies it's a kind of good i think they're going up i think they're going higher i think you know valuations are going to look even more crazy but i don't think it's a good thing and it's not something that i'm particularly you know happy about you know i it scares me a bit actually okay um very well put and and consistent with a number of the experts that we've had on this program recently so um i'm going to sort of state what i can see sort of as their consensus view and you tell me if you you know agree or disagree but they they do see um a period of sort of continued i mean some see a true melt up coming but but a period of continued um you know upward pressure on prices as this um all this central bank uh you know over stimulus reaches its apex um than to be followed by by some sort of reckoning you know some people see that as a correction some people just see it as crushing inflation that that forces the the fed to have to start raising rates you know whatever whatever that's going to be um so do you sounds like you're seeing something similar right where you're like the the the the train is already on a runaway course um it's got a ton of momentum behind it doesn't look like the uh the engineers driving it are gonna slow it down willingly but you just don't see it being able to continue sustainably on that course for all that much longer and that when it when it does hit it's it's reckoning it's it's not going to be fun for anyone um is that all accurate well i i i i i'm not sure i agree with all of that you know i the problem i have with inflation uh you know of the cpi variety because i think you know the asset inflation i think is is is pretty kind of clear and it's pretty clear what the source of that asset inflation is the the real inflation is in the bond market that's where the um that's where the the the price to torsion is that's where prices are too high right bond prices are far too high real yields are far too low and that just ripples out across the entire spectrum all assets are all assets are commensurately overvalued in the way that the bond market is overvalued so that's what causes this kind of wide um uh that this um widespread asset inflation all right and i'm sorry to interrupt there dylan but is that because basically it's another way of stating that is that debt is just becoming way too cheap and so people are using that debt to drive up asset prices of all types and kinds um um debt borrowing is becoming too cheap yes yeah right so this is what this is why you get uh i think this is where where the excesses come from right so this is why you're seeing you know you know ever ever growing pe deals i think this is why you're seeing higher uh private market valuations certainly why you're seeing higher equity valuations um equities are real assets they're discounted by a real interest rate and by a real discount rate and that real rate has been pushed into negative territory um implicitly i don't think they've gone out to target negative real interest rates but implicitly by targeting such a low nominal um interest rate uh with inflation expectations you know roughly at two percent because inflation cpi inflation is roughly two percent that just leaves real interest rates as the variable has to adjust so the effects are effectively keeping i think we're already in a kind of yield control a kind of quasi-yield control type environment the effect of of keeping um nominal yields artificially low is that real yields get depressed um and that's that actually just the valuation arithmetic is that that pushes everything else up right so it's not just about um the the cost of borrowing right before you get you just just the actual the valuation of arithmetic is if you've got negative real yield you're going to have much higher um equity valuations right you could never if you've got very low nominal rates you're going to have much lower costs of borrowing right for a given credit risk premium in the um uh and and the credit markets and so you're kind of you see that very very clearly in terms of the flips you know if you're triple c company you know you've probably got i think triple c companies have got like a 50 chance of developing over the next 10 years right you're borrowing at six percent you're barely credit wealthy and you're borrowing at six percent so of course that just leads to um excesses and a misallocation of capital um and uh and so you know do you to your point um you know it's these excesses that ultimately leads to you know a kind of deflationary boss so i i i kind of i'm not really i don't know about inflation cpi inflation to get back to your question i i really i do understand the arguments and i i i do find myself feeling very unnerved by some of the policies that i see and some of the the kind of normalized actions that would have been kind of breathtaking 20 years ago um but this kind of mnt world that we're in i i find quite disconcerting um but i i just i was worried about those things 10 years ago and look where we are and so i don't quite know where the the tipping point is and so it's not clear to me that we suddenly get this you know massive massive inflation by the way i'm not saying that that i'm relaxed about it and i don't think there's going to be a huge inflation problem i'm just saying that i don't maybe there won't be right but for all the reasons that we've been wrong or guys like me have been on the last 10 years we'll be wrong for another 10 years you know um so i just i i kind of i'm quite agnostic on on on that particular aspect of it yeah well it sounds honestly just sounds like humility to me you know there's there's a lot of people that have watched this market do what they didn't think it could do for much longer than they thought it could do and so you know in many ways i think the the same rational thing is to take the position you're saying which is hey look this is what i think may happen but but we don't really know and so as somebody who manages capital i want to get into this a little bit later in the interview yeah i'm curious you know what steps you're taking because you you kind of have to pick a course but you also have to put in some insurance or defenses in case your primary thesis you know continues not to be exactly what reality is uh before we get there though i i want to well two questions for you um first again asking you to put on your prognosticating goggles um we've been talking a bit about inflation um uh so once you don't walk but you'll ask me anyway and i'll answer anyway okay [Laughter] um but uh so inflation stagflation disinflation deflation um which flation do you think we're most likely to experience you know over the near to midterm from here or maybe it's a progression of flations um do you have any strong opinion what's the um what's the medium term what coming up some years let's say the next six to nine months oh six or nine months um i think probably disinflation on a cpi basis okay okay and for folks watching you don't know what disinflation is it means uh you still have uh you you still have growth it's just your rate of growth is is diminishing the rate of except the the rate of inflation declines yes it's still positive but it's it's declining yeah and i think you get out just with base effects you know you you you know you will start to see that as you you know you know you kind of have as these things kind of start to unwind and i think for what it's worth you know i think that the trend for kind of durable goods inflation is still negative you know um and that's been that has been the trend not you know for decades and i think there's good reasons for that and i i think that's going to continue so and i hate i hate to say it i don't hate to say but it's an unusual position to find myself and i do kind of agree with with what you know most of the kind of central bankers are saying right now on inflation and um you know that is that it's transitory um and uh you know i i think that the if you look at the inflation markets they've actually been quite relaxed throughout the whole episode and and the way you see that is not you know not by looking at you know five-year inflation expectations or two-year inflation expectations look at the difference between ten and five or look at the difference between 30 and five and what you find is that that inflation curve is massively inverted so the inflation market is telling you with rightly or wrongly but the inflation market is saying you know hey we're relaxed we're kind of relaxed here you know we don't think that there's we don't think that there's anything to worry about long-term we're not that nervous about it yeah and by the way i'm not sure i'd say i'm not sure on a 30-year view he thought he uses a hell of a long time and so for kind of 30-year inflation break-evens to be where they are is you know i i i don't think that's very attractive you know real used to be basically zero on 30 years i think is a very very unattractive prospect um but um but yeah for what it's worth i i think that they you know the the inflation markets have been um have have have not questioned the fed's credibility and on this particular issue i'm not particularly i don't think that inflation is going to blow off over the next 12 months okay great well look um i i want to talk to a um just a fundamental um reason for the existence of central banking um which is issuing sovereign currency and on that topic i want to just read a tweet here that you just recently put out um independence of currency issuance is as essential to democracy as independence of the judiciary it's not that central banks should be independent it's that they should be abolished currency issuance should be constitutionally denationalized can you explain your position here and and can you also clarify what you mean by a constitution constitutionally denationalized currency yeah god when did i read that yeah that about a month ago yeah that's right no i i i do remember just when you read it back to me it's it sounds like um there's a lot in that um uh would so what i mean by that um i guess i i think that um how to summarize the ultimate source of um i think um government power um one of the ultimate sources of government power is um state power is as the printing press right uh they have the ability to issue um a currency senior age is is is is i mean it's difficult to understate really how significant um how much power that that grants them i mean if you consider this mess in afghanistan which by the way people who have been talking about afghanistan being a mess you know one end of the spectrum they've been called basically they've all been developing cranks right basically anyone who um if you were at the right end of the spectrum you know you were well you were just unpatriotic right if you're american you're unpatriotic if you if you're at the wrong end you went to jail right that's the way people have been who um uh uh raised questions about what was going on in afghanistan have been treated and if that's if you're american and if you weren't american you just obviously hated america right or you were jealous of american greatness all right you had this very strangely kind of irrational um environment where you couldn't really have much of a conversation about it now all of a sudden it's a disaster and everyone knows it was always a disaster and what the hell would we do now suppose you'd have been like people had been asked to raise people who'd been asked to pay a surcharge on their tax on their income on their on their income tax to fund this war in afghanistan actually not just to fund this war in afghanistan but to fund the war in iraq and to fund an nsa surveillance program etc supposedly you have line items on your tax statement and you could opt out of those ones that you didn't like right how many people do you think would have actually um uh opted to pay tax to fund a war in afghanistan right or like by the way not that i would have thought not very many right so how much does the war in afghanistan cost um i think kind of estimates vary but you're probably talking about a trillion dollars how much is the fed printed as part of his qe program kind of three to four trillion from memory i don't know you can google and get the answer you know that they have science at 3 4. so i think there's a very strong argument that the fed funded afghanistan and i feel that that's argument and of course it would fund afghanistan because you said the purpose of central bank was to issue fiat currency because the purpose of central banks if you go back to the origins of central banking and as i'm talking about the um uh the the bank of england specifically and but if you look at even the creation of the federal reserve the the prior legislation of the federal reserve which was really enacted in the um which centralized the banking system in america which was really enacted during the civil war the purpose was to fund government that's what the purpose of central banking was to fund government there was nothing to do with price stability certainly nothing to do with financial stability it was to fund government and so i the reason i wrote that tweet was because i've been reading about the american civil war and the end of the free banking era and it kind of occurred to me the reason because before the civil war america had a uh you know from 1837 until the 1861 1862 and america had completely free banking and the reason it was crushed and which it was the legislative side was completely crushed was because you know a system of free banking wouldn't wouldn't have funded the war efforts right and again and again where you stand in the civil war and and and you know which is an incredibly controversial topic still that's not really what you know i i i i want to get into um but uh although if you if you if you find it interesting we can do um but the the astonishing thing to me was that it was basically set up to fund a war effort and if you look at the the first world war um uh it was exactly the same thing all central banks of all participants funded the first world war by printing money right and catastrophically uh the germans who lost and then had to pay reparations with prince of one again it all comes back to um the central banks being and governments being able to coerce central banks into funding their their their desires which frequently are um the making of war so you know that that was it was really just to try and isolate just how important a source of of of of power um uh politicized currency issue actually is and so that's kind of what i was what i was getting at and i think that you know the other main so the other reason why the government has huge power is because the government can legislate right and so the reason why we have an independent judiciary which goes all the way back to magna carta is because the government should be a part of the legal system it shouldn't be above it and when you get into countries like russia or china the government basically just weaponize the legal system against their enemies right so most people who believe in democracy and believe that citizens should be sovereign believe that the judiciary should be completely independent from from the executive and all i was saying was well if you actually look a little bit deeper into most of the kind of catastrophic events you know in recent history most of the big wars they've basically been funded by central banks right so if you really you know we got we've got involved in these conflicts that most people don't didn't want to be involved with right the government could do it because government could print the money therefore government could fund it so that was basically the thinking um you know is it such a bad idea to completely eliminate central banks as a constitutional point so listen we're never going down this path again because ultimately um fine and independent money is a check on power well so i think that's such a fascinating point and we have a lot of discussions on this program um about the the roles of the central banks and i think to be honest i could say the culpability of the central banks in a lot of the ills that we're dealing with right now and certainly you brought up kind of the funding of the war machine but you could also just look at you know anything from um the devaluation of people's purchasing power here the um uh rock-bottom interest rates that have basically just declared war on savers um or people that you know need to live off of fixed income uh in their in their old age um and certainly and you know you can make arguments one side of the other but if you look at our policy responses to both the global financial crisis and then again to the coronavirus pandemic um the actions of the world central banks i think have at this point pretty irrefutably led to a tremendous acceleration in wealth inequality right so there's all these different reasons why i think we can look and say look the current way in which the central banks operate um isn't necessarily in the best interests of the general public there may be more in the best interests of of the people running the system whether it's the institutions themselves or the people who benefit the most from these policies um so anyways there's there's i think lots of reasons to try to imagine a different model yeah well look i want to get to um you know what you have to do on a daily basis right which is you have to sort of take all these factors uh into consideration both what the institutions are doing um but also you know mapping all the soft you know elements in here in terms of the human factor and you know the power dynamics and all that stuff i mean to be honest you know most of what we've been talking about so far none of that figures at all i don't factor any of that stuff in to what we do in the portfolio i just find it very interesting right and i kind of enjoy toying with some of these ideas and playing with some of these ideas and you know but in terms of the practicalities of managing money and um and managing capital i'm not really sure how practical any of the you know the previous 45 minutes well i think one practical point could be and you correct me if you if you disagree but as you know it sounds like given everything we just talked about it's pretty easy to come to the conclusion that the central banks are going to continue to print uh and continue their current policies for as long as they can more or less get away with it without the system you know breaking underneath them and so as you look at where asset prices are going like you said earlier you know in a rational world maybe they should be a lot lower but they might not be for a while given all this sort of artificial uh support that the central banking system is giving to them yeah well i mean i think that um uh i mean yes i i agree with of that i i would also kind of just you know to bring it back to us to the valuation and stock markets you have um um or just all markets really um you know the actual uh the spread between kind of equity yields and um real treasury yields is actually buying in line with its historic norms right finally so if you're if you're see if you know if you want to say well our assets markets overvalued i think the answer is yes but then if you look at the relative pricing of asset markets you know um are credit markets rich at the moment yes but they're at the rich end of the historical range they haven't really we haven't broken new ground so you can't say well this is unprecedented richness and credit pricing because it's not unprecedented we've been here a bunch of times before and it's never ended well okay so yeah i'm not trying to kill it but what do i make excuses for i'm not saying it's a good thing but it's not kind of unpre so you could say that the market pricing of risk is is more kind of cyclical at the moment you know relative to the risk-free rate look at the price of equities of the variation of equity markets they're kind of in line with their historic norm so again you would say well the variation of equity markets relative to the bond market the real pricing of the bond market kind of looks kind of vaguely rational the real screw-up is in the in the bond market and that's what elevates the the whole thing right so what do you think that is going to happen to um to uh to bond yield my guess is that they probably don't let bond you'd rise too high and as soon as you know like the taper tantrum you know whenever it was 13 um if bond yields actually do start to move too quickly they'll they'll they'll intervene and they'll keep them down and so if they're going to peg bond yields lower um if inflation expectations were to rise um then that pushes real yields down even more and the viewers go down more then equities go up more right so it doesn't you know and equities just could equities have in the past traded very very richly against bonds right now they're not there's nothing at all to say equities can't just now start to trade richer against government bonds right i think there's a there's lots of good reasons for equities to trade much more tight versus government bonds than they are today um for example you know a friend of mine said why why do i need to bother with all this inflation protection nonsense where i can buy google right i can buy google on a kind of free cash flow yield or like now wherever it is you know six odd percent growing at double digits you know that's my expected return right i don't really have to worry too much about a dominant um player dominant um uh protestant participant still uh is likely to dominate its industry for the foreseeable future et cetera et et cetera you know you know if if buffett was was younger he would be all over google right he wouldn't be that interested in coke right why why do i need to bother with what and i think there's a very strong logic to that as an argument right in other words equities if you're really really wrong about inflation just on the really good equities and i think that's kind of what's happening so in that kind of scenario why can't equities price rich against treasuries because they're not at the moment right so there's all sorts of scenarios where equities can just go so much higher than they are right now you know and yes the overall variation will be crazy and you know it's relative to what you know relative to negative real yields and so if you think that the fed are going to kind of fight to the nail to keep real yields roughly where they are now or even lower it's difficult to really get too bearish about equities you know in my opinion all right so i want to get to the specifics of kind of how you're allocating your portfolio right now but really quick to the point you just made so how would you when you look at say an indicator like p e ratio you know p e rate historical p e ratio averages or like the buffett indicator um you know p e's are i would say at the at the very high end of the historical range and the buffett indicator is off into the stratosphere i mean it's often territory it's never been in before so um for folks that kind of look at those historical valuation indicators um what would you say to them in terms of saying equities can still go a lot higher i i i feel that um and i'm what i'm about to say is is probably considered heretical uh in many places but i i feel that it's all relative you know i don't think there is such a thing as absolute return right you know if you you know the shell of pe ratio you know and into the 30s you're probably looking at two and a half to three percent depending on how you calculate 293 percent sheller earnings yield right um you know maybe like you know add on a percent of growth maybe right and i think because the growth in the economy has not quite been matched by the growth in an eps but anyway i don't know a percent for growth right and be generous and say you know okay so that's three and a half to four percent that you get you're you know your yield plus plus growth right that's your real yield that's your real expected return okay that's it no is that good are you happy with that or not is is that good returns that budget and i'm i i would answer the question for you if to give a serious answer as a three or four percent real yield attractive you say well it depends what get elsewhere right it depends what you can get everything if i say well if i i can actually give you you know there's a there's a distressed seller of inflation-protected securities over there and effectively selling for 10 yield you know would you prefer that of course you would right so it's kind of nonsensical really to talk about to me it's not sensible to talk about the shallow pe ratio without also talking about real yields it doesn't make any sense to me all right because you have to if you're not good if you're going to say well you're four percent that's crazy which it is it's crap it's a terrible it's a terrible risk adjusted return in my view but where else are you going to go all right so that's i you know to to to people who kind of say well i can't go higher because pe's are already low look at where real yields are right and and tell me why um um real yields are are irrelevant to where the equity market is tell me why yeah well i think and and might want to tear this to shreds but i think you know most people um are choosing equities right now because they feel like they've got a bayonet at their back right where they just they can't get good return anywhere else right and so they're just getting shoved up their risk curve right they're not happy about it but in many cases they they you know either fund managers like you feel like they have to generate some return for their clients or retirees feel like they just got to have something to eat right so they gotta they they they go up the risk curve but it's not something that they necessarily feel is sustainable or good yeah and i think this is why um um what central bank is doing is is so sad really because you're you're kind of forcing uh people into you're forcing people to take risks um and um you know i i kind of feel that most people who are buying equities are buying equities because equities have done quite well recently you know the nuance of the valuation kinda is not really a factor in most people's decisions they've gone up so i'm buying them so they're good they're great if it goes up with that that's that's that's the logic and you know the more the more the fed does what it's doing um and distorting these kind of prices i think the more that type of attitude wins right and therefore the more that type of attitude dominates and that's what you're seeing and so you suck in um these kind of unsuspecting um uh investors in a bubble all right and they're the ones that always get hurt all right so i find it kind of very uh ironic that the people who are talking about the the absolute steadfast need for cryptocurrency regulation because we have to protect the america we have to protect americans for christ's sake right these are the same people who have blown a bubble in every single um asset class that you can name um it's very ironic well all i can say is hallelujah brother uh totally on the same song sheet as you there all right well look in in you know landing the plane here i do want to make it as practical practical as possible for people so uh two main last questions for you the first one being so given all the challenges and and the smoke and everything that we're talking about here uh given how hot the the central banks are cranking up the heat in the oven how are you allocating capital right now in this environment what what does look good or at least good enough to you right now we hope you've been enjoying this animated discussion with fund manager dylan grice the interview continues over in part two where dylan explains his firm's highly unconventional investing strategy which seeks to insulate itself from many of the risks that he and i discussed in this interview to watch part two just click on the link provided in the description of this video below or go to youtube.com slash wealthyon but before you go please don't forget to hit the like button and then click the subscribe button below if you haven't already as well as that little bell icon right next to it it only takes you a second and it really does help us out as the more subscribers that this channel has the more big name experts we can attract onto this program in the future oh and if you'd appreciate a free no strings attached portfolio review by a financial advisor who can help manage your portfolio with the risks that dylan highlighted here just go to wealthyon.com and we'll help set one up for you okay i'll see you over at part two of our interview with dylan grice

2021-09-12 14:32

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