Tag: law of intended or unintended consequences

James Grant Transcript 09-28-12 #914

September 28, 2012


#914- 9/28/12


CONSUELO MACK:  This week on WEALTHTRACK, financial historian and thought leader, James Grant, attacks the Fed’s policies of zero interest rates and massive purchases of treasury and mortgage bonds as dangerous to the economy and damaging to savers. Grant’s Interest Rate Observer’s James Grant is next on Consuelo Mack WEALTHTRACK.


Hello and welcome to this edition of WEALTHTRACK. I’m Consuelo Mack. Federal Reserve Chairman Ben Bernanke has been widely credited with playing a key role in saving the global financial system from spiraling into a deeper recession. As a recent Financial Times headline read, “Central Bank Action Lifts Gloom”; “Bold Fed and ECB Moves Cheer Investors- Confidence Increases in U.S. and Europe.” There is no question that the Fed and to a lesser degree the ECB, the European Central Bank, are pulling out all stops to boost economic growth, investor confidence, and stock returns, going far beyond what their critics maintain is their proper role. As this week’s guest, financial journalist and historian James Grant told me, “Central bankers have morphed into central planners.”


The Fed, unlike other central banks around the world, has a dual mandate. Starting in 1977, Congress stipulated that, similar to other banks, it is supposed to ensure price stability, i.e. keep inflation in check. More recently, the Fed has focused on preventing deflation and has said its targeted inflation rate is 2%. Its second and unique mandate is to “promote effectively the goals of maximum employment.” With unemployment at more than 8% and long term unemployment near 15%, the Fed is a long way from meeting that goal; which is why the Fed recently pledged to keep short term interest rates near zero until mid-2015, an unprecedented seven year stretch, continue buying U.S. treasury bonds to keep interest rates low, and purchase $40 billion dollars a month of mortgage backed securities until the labor market “improves substantially”; in other words, it’s an open ended commitment.


Perhaps the most stunning statement by the Federal Reserve Chairman came in a recent speech in Jackson Hole, Wyoming. We will have the full text on our website, wealthtrack.com. In describing all the unusual policy actions taken he said: “Central bankers in the United States, and those in other advanced economies facing similar problems, have been in the process of learning by doing.”


This week’s guest is appalled by the Fed’s expansionist policies and worried about its known and unknown consequences. He is Financial Thought Leader James Grant, editor of Grant’s Interest Rate Observer, a twice monthly, self-described “independent, value oriented and contrary minded journal of the financial markets.” It also happens to be a must read among top professional investors. Jim is also an historian and author. His most recent book is Mr. Speaker! The Life and Times of Thomas B. Reed. I began the interview by asking Jim if the Fed wasn’t just doing its job: promoting maximum employment and price stability.


JIM GRANT: That is a good legal question. I think the subsequent financial question is whether there is any reason, either in theory or in common sense, to suppose that suppression of interest rates- and really let us call a spade a spade- price control is going to improve the prospects for working Americans. It seems to me that everything argues against that. The Fed, again to use plain talk, is suppressing interest rates. It is muscling around the structure of interest rates known in the trade as the yield curve. It is virtually allocating credit with its exertions, and it’s in the business of price control. Now, that has never worked. Chairman Ben Bernanke in remarks at Jackson Hole, Wyoming now a week or two weeks ago said that… he said, “We are learning by doing.” Learning by doing. Now, we have thousands…


CONSUELO MACK:  And he’s a financial historian as well.


JIM GRANT: No, he’s not.


CONSUELO MACK:  Well, that’s what he supposedly he is. Supposedly, he’s a student of the Great Depression.


JIM GRANT: He’s the kind of financial historian, if I may say so, who neither reads history nor writes much of it. That’s the kind of financial historian he is.


CONSUELO MACK:  All right.


JIM GRANT: There is a record of monetary history going back thousands of years, yet he says we are learning by doing. This, to me, is not the utterance of an historian.


CONSUELO MACK:  So when you said what we’re having in this interest rate suppression, which means that basically by buying Treasury securities and mortgage-backed securities, they are sopping up supply and, therefore, they’re keeping interest rates low.


JIM GRANT: And they are planting an idea in the mind of the market that interest rates will remain low and, that if they do move up, the Fed will be there to tamp them down again. So they kind of bring the marketplace into partnership. People are happy to play along with the Fed. It’s an easy way to make some money.


CONSUELO MACK:  People being Wall Street, institutional investors.


JIM GRANT: Yes, professional investors. Right, and today the chairman of the Federal Reserve Board talked about how the stock market’s going to go up which is nice for those who deal in common stocks or who own them, but for those about whom he’s supposedly is most worried, namely the victims of this most miserable and protracted of labor market slumps- not most miserable, certainly among the more protracted labor market slumps- to these people, rising stock prices…




JIM GRANT: Yeah, savers and people looking for work.


CONSUELO MACK:  But it’s interesting in that when you look at what the Federal Reserve has done, is that we have had a very positive response in the stock market to the expectations and the actuality of the Fed’s actions.


JIM GRANT: Sure, it’s free money. It’s free money, and it’s no competition from the bond market. I don’t mean to say that every single company listed on the New York Stock Exchange or NASDAQ is unworthy as an investment. On the contrary, there are, I think, some things to do in the stock market- there perhaps always are some things to do in the stock market- but the Fed has got it into its head that if it succeeds in levitating the average level of stock prices, that good things happen from that. Now, shouldn’t it be that the stock market goes up because good things are happening to the companies that issue the common stocks? I mean, in his rhetoric, in his language of technical eco terms, in these bouquets of calculus and algebra that fill the footnotes and the technical sections of these papers, they seem not to focus on two and two.


CONSUELO MACK:  So let’s talk about the law of intended or unintended consequences in this point. So what are you seeing? I mean, what kind of distortions are you seeing?


JIM GRANT: Well, the distortions are all around us and in his speech in Wyoming, Chairman Bernanke enumerated four there the tritest and perhaps the least interesting and meaningful to Americans of the many that are possible. For example, he neglected to mention the fact that if you save… there must six or eight people in America who do save. Right? Many of them watch you.




JIM GRANT: He neglected to mention … he might have said,” Sorry the absence of interest rates is starving you, but we don’t mean that to happen.” He didn’t even mention that. He might have mentioned that zero percent interest rates makes hash and nonsense out of credit analysis. The money markets are full of instruments like commercial paper, certificates of deposit that yield just about nothing before tax, after tax even worse, worse than nothing, and people spend time still analyzing the credit worthiness of these claims. But why? If they yield nothing, why bother? So the suppression, the manipulation of interest rates distorts and makes a mockery of credit analysis and, furthermore…


CONSUELO MACK:  Well, you know, most of us don’t care about credit analysis. You do.


JIM GRANT:  Oh, yes you do.




JIM GRANT:  We cared about it in 2008 when we discovered no one was doing it, and another thing, Consuelo…


CONSUELO MACK:  Put me in my place.


JIM GRANT:  No, no. Another thing that the Fed has not thought about apparently is that all of us who invest, either part time or full time, are kind of doing it in this hall of mirrors. Right? We don’t know exactly what values are, because values to a degree derive their value from some calculated stream of discounted future income; but if interest rates are zero, how do you do the arithmetic? Right? So investment values are distorted, and they’re distorted furthermore because they go up because the Fed says they should, not because companies are doing better. The whole thing is kind of nuts when you think about it.


CONSUELO MACK:  So isn’t there some method to Ben Bernanke’s madness? If he’s keeping interest low, that means that the people who are loaning us, I should say, who are loaning us money, the Chinese and the Russians, for instance, and the Japanese, then in fact the value of their Treasury holdings will be stable at least.


JIM GRANT:  Well, if I were a creditor to this government and running affairs in China or Russia or some place or Japan, I would like some interest income just to make me feel as if they cared. I think that by suppressing interest rates and by creating hundreds of billions of dollars, new dollars a year, the chairman is not, after all, reassuring our creditors, but he ought to be alarming them. He ought to be alarming our thoughtful creditors. Now, some of our creditors don’t care so much about the market value of their obligations, of American obligations. What they care about is manipulating or suppressing or managing their own exchange rate so they can export more to this country. So they’re not so concerned with interest income as they are with keeping the factory’s chimney smoking.


CONSUELO MACK:  Well, just one more point, I mean, along these lines is the fact that the Fed has been pretty consistent since 2008 in that they have pulled out all stops. They have done whatever they can do. I mean, they’ve done it kind of incrementally, but now…


JIM GRANT:  Yeah, but from time to time you never knew exactly what was going to happen next.


CONSUELO MACK:  True. You didn’t know who was going to be bailed out, who was going to be financed, right.


JIM GRANT:  And so, again, what this amounts to, Consuelo, in my opinion, is a full-scale federal war on Adam Smith’s invisible hand. This is a campaign against what the economists call the price mechanism. It’s this miraculous human contrivance that allows Wal-Mart to stock its shelves because at a price merchandise moves or it doesn’t move. That’s the way a complex economy is coordinated. It’s so simple, we scarcely pay attention to it, but this miraculous contrivance is exactly what the Federales are trying to stamp out. They put their thumb on the scale. They don’t want prices to be cleared in the marketplace. They want to dictate them in the interest of macro-economic stability. How the heck do they know what’s going to be stable?


You know, there was an episode in our not-so-distant past. There was a depression in 1920, ’21. It’s the depression Chairman Bernanke never mentions. It lasted 18 months peak to trough, and to meet this cataclysm, this disaster… you know, wholesale prices were down 40%. Unemployment went from three percent to twelve percent.


CONSUELO MACK:  That’s a depression.


JIM GRANT:  Real activity declined by nine or ten percent. To meet this, the Feds: A, balanced the federal budget and, B, raised interest rates. And guess what? The thing ended. Markets cleared. Assets got cheap. People bought them because they were bargains, and it was off to the races. That was a kind of free market depression. What they’re doing in the past five years or whatever it’s been, one loses track, is everything except that; and the consequences in no small part are the 23-year-olds at home in their bedrooms of their childhood wondering when somebody’s going to respond to their e-mail looking for work. In the interest or with the best of motives of making a capitalist system more humane, they have made it hugely inhumane. Let markets work.


CONSUELO MACK:  So Jim, one of the things that you do in Grant’s Interest Rate Observer aside from analyzing this kind of behavior and telling us in plain language what’s going on, is that you also give investment advice as well, and so how do we invest in a period like this?


JIM GRANT:  Well, with an eye always to a margin of safety, but it seems to me that from time to time Mr. Market does present one with what seems like a bargain. For example, we have recently waxed bullish on, of all companies, General Motors. I spent the last two hours…


CONSUELO MACK:  Right. I almost fell off my chair when you told me that.


JIM GRANT:  …sermonizing against federal intrusion into our commercial and financial affairs. Government Motors has emerged from bankruptcy with the cleanest of balance sheets, with a new and, I think, rather energized management structure. It means to do better. The American odometer has put on a lot of miles. We have the oldest, I think, oldest car fleet on the road right now.


CONSUELO MACK:  So there will be demand for new cars.


JIM GRANT:  Yeah, people are going to want that new car smell. GM, I think, is in a good way. Now, no good value story is complete without the object of one’s affections having a lot of hair on it. Right? Something has to be wrong with it to put people off. In the case of GM, it’s the government’s important equity holding. So the bearish case on GM is, why buy this thing? It might be cheap, but it is cheap like six times the estimate for next year of earnings. But why buy it if the government’s going to come out and dump its stock? Well, GM, we think, may very well be the buyer of that stock itself. It has the balance sheet to do it. So for all those reasons, for operational reasons, for financial reasons and for strategic reasons, perhaps we think that GM is a bargain.


CONSUELO MACK:  So let me ask you.


JIM GRANT:  And we add this. And because it’s well-financed, because the balance sheet is clean, the chances of permanent impairment of one’s capital, which is always a consideration, we think are low. So that’s our story on GM.


CONSUELO MACK:  As far as the investment environment and what’s going to do well in the market and what’s not going to do well, given the backdrop of what the Fed has been doing, so what do you… what are the opportunities that are being created? What are the biggest risks that are being created?


JIM GRANT:  I think that the biggest risk… and I’ve been so wrong about this. I preface it with my own assurances that my judgment is just as infallible as the chairman’s, although what I don’t do is impose it on others, but in my opinion, the so-called safe assets are the unsafe assets, and the so-called risky assets paradoxically will turn out to be the remunerative assets. Today we live in this land of risk on and risk off. This is what you hear on cable television with Wall Street, this kind of yak-yak you hear on Wall Street, and conveniently the brokers define these categories for us. We have to think safe or risk off… let’s see, risk off. Right. Safe assets.


CONSUELO MACK:  Right, treasuries.


JIM GRANT:  Right, sovereign. Yes, U.S. Treasuries and, of course, let us not forget European sovereign credit yielding less than zero, so-called, the dramatic on northern European …


CONSUELO MACK:  Swiss bonds.


JIM GRANT:  Yeah, Swiss and Danish and German yielding less than zero. So you pay them to keep your money. Doesn’t that sound wonderful? Safe, safe. Well, as we learned in the ‘60s, ‘70s and early ‘80s, and have learned subsequently in different settings, safety is a defined term. Bonds are not intrinsically safe, nor are stocks intrinsically risky. There ain’t no intrinsic in investing; it’s all a matter of price and value. If bonds yield nothing, are they really intrinsically anything except risky? No, to answer my question. They are risky. So in my opinion, the years to come will see a great shifting in our perceptions of risk.


So if you have a good company, and there are many good companies that have the capacity to adapt, that can deal with inflation when it comes, that can deal with deflation, that can adapt their products to a changing marketplace and that are priced at, say, 13 or 14 times earnings that are yielding two and a half percent, to me those are, relatively speaking, pretty good investments over time compared to Treasuries and other sovereign emissions yielding zip. So if I had to pick, and I do, between stocks and bonds, I pick stocks, and if I had to pick between risk on, so-called, and risk off, give me risk on. I want what they regard as risky, and I would sell what they regard as safe.


CONSUELO MACK:  And as far as the stocks are concerned, are there some stocks that represent the best, again, you know, best investments as far as price, value, yield?


JIM GRANT:  I mean, Google, for example, we wrote about. It was a little bit lower, but we wrote about it this summer, and it had a market multiple. It was like 13 or 14 times the estimate, and this is one of the great collections of American and, indeed, of world intellects, and they sit around all day thinking stuff up, and they have a good profitable business, a fabulous balance sheet. They seem to have the future in sight. They have demonstrated that they know something about technology beyond the fax machine.


And I’m thinking that, as compared with a Treasury that yields little or a Treasury inflation-protected security that yields less than nothing, that Google in a market multiple is a pretty good warrant or option on human progress.


CONSUELO MACK:  So where do we go for yield?


JIM GRANT:  Well, there ain’t none. There is very little natural yield. However, there are what used to be called business man’s risks. We now call them business people’s risks on Wall Street that will deliver you some yield at a reasonable risk. One of these opportunities is called prime rate or floating rate funds, and they are funds of bank loans. Now, the loans are to leveraged or indebted companies, but you as a lender to them in the bank level get a senior claim, and the senior claim is, I think, a safe claim, and these leveraged loan funds as they’re called, or prime rate funds, deliver interest income that will go up if interest rates go up, and over the past 12 months or so, they’ve delivered seven or eight percent over that time in interest income, and I think they will likely continue to do that. They have been much less popular than speculative grade or junk bond funds. Junk bond funds have had huge inflows. These prime rate funds have had very little in way of investment inflow. So we like those. They’re a decent business person’s risk for interest income.


CONSUELO MACK:  So are there any particular prime rate funds that… ?


JIM GRANT:  Well, Eaton Vance has one that we have spoken well of, for example. All the big mutual fund companies have them. Another set of interest spinning entities in this world of no-interest income are the mortgage real estate investment trusts. Annaly, NLY, is one. American Capital Agency, AGNC, is one. Hatteras, HTS, is another. MFA, same ticker, MFA, is a fourth. We’ve written about them. We followed them for years and years. They are leveraged, meaning they do business with borrowed money. They borrow short and lend long. There are risks, and there are risks that, for example, that the Fed might succeed so well that it crushes all interest spread in our world of mortgages, but these things yield 12 and 13%. They are trading at book value or slightly above or slightly below it. Each of the four I mentioned has some particular merit and, in some cases, some characteristic frailty, but taken as a portfolio, these four, it seems to me, again, in the context of taking some reasonable risk for income, these are not a bad way to proceed.


CONSUELO MACK:  And I know that Annaly has been a past one investment recommendation of yours, and we’ve had the CEO, Mike Farrell, on WEALTHTRACK a couple of times in the past. As far as, you know, we’ve got an election coming up, so what do you think the impact of the election is going to be on the markets? Is it going to make a big difference?


JIM GRANT:  Well, we can talk about religion next, now that we’re talking about politics, and this is– I’m not sure what my political views are worth, but I’ll give you them. It seems to me that this issue that the election is really about from the financial point of view, the election is about the price mechanism. It’s about the invisible hand. It’s about supply and demand. Do we prefer that to the government? That’s the question. I mean, everything else is being discussed, but the essential financial issue in this, to me, is shall we give, at long last, shall we restore capitalism to Wall Street? Shall we restore the price mechanism to its proper place in our money and capital markets? Shall we get out of the business of suppression and manipulation?


Now, Mitt Romney is a most imperfect champion of these ideas, but he is infinitely better than our incumbent in my opinion. Therefore, I mean, Grant’s Interest Rate Observer has only endorsed one political candidate in all of 30 years in business, and that was Grover Cleveland, and he was dead and we endorsed him. And I’m not going to endorse Mitt Romney, but I am going to vote for him.


CONSUELO MACK:  That is great. Jim Grant from Grant’s Interest Rate Observer, thank you so much for joining us on WEALTHTRACK.


JIM GRANT:  Well Consuelo, it has been my pleasure. I thank you.


CONSUELO MACK:  At the end of every WEALTHTRACK, we try to leave you with one suggestion to help you build and protect your wealth over the long term. This week we are taking the lead from our guest, Jim Grant, who mentioned a portfolio of mortgage backed REITs as one way to feed our widespread yield starvation. This week’s Action Point is: consider investing in REITs through a traditional real estate investment trust index fund. Morningstar’s favorite is the Vanguard REIT ETF, symbol VNQ, the largest in the category with low fees and less volatility than the competition. Incidentally, Morningstar recommends holding REITs in a tax-deferred account, such as a 401k, because their dividends are taxed as regular income.


I hope you can join us next week. We are going to interview Great Investor David Winters of the five-star rated Wintergreen Fund who is going to challenge three big investor misconceptions. Don’t forget, if you are interested in seeing this week’s program again, you can go to our website wealthtrack.com. It will be available as a podcast or streaming video. And while you are there, you can also see additional interviews with WEALTHTRACK guests answering some unusual questions in our new and improved WEALTHTRACK Extra feature. And that concludes this edition of WEALTHTRACK. Thank you for watching! Have a great weekend and make the week ahead a profitable and a productive one.

James Grant: The Federal Reserve’s Most Outspoken Critic

September 28, 2012

Federal Reserve Chairman Ben Bernanke has been widely credited with playing a key role in saving the global financial system from spiraling into a deeper recession. As a recent Financial Times headline read, “Central Bank Action Lifts Gloom”; “Bold Fed and ECB Moves Cheer Investors- Confidence Increases in U.S. and Europe.” There is no question that the Fed and to a lesser degree the ECB, the European Central Bank, are pulling out all stops to boost economic growth, investor confidence, and stock returns, going far beyond what their critics maintain is their proper role. As this week’s guest, financial journalist and historian James Grant told me, “Central bankers have morphed into central planners.” Continue Reading »

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