My interview with Hugh Hendry, the legendary Eclectica Asset Manager
This interview was definitely one of my favorites because Hugh challenges our understanding of things.
We talk about the Federal Reserve, the 1920 and 1930s deflation, Japan in the 1980s, deflation in 2008, velocity of money, the new cycle of the economy, and how your portfolio should look today!
US banks made relative break-outs off the back of negative policy rates. As Grant-the legend-Williams would say, Hmmm pic.twitter.com/mLYFF2EycP
— Hugh Hendry Eclectica (@hendry_hugh) May 4, 2020
Hugh Hendry’s Background
George: All right, guys, it gives me a great deal of pleasure to bring someone to the Rebel Capitalist Show that I really, really enjoy watching on Real Vision Television.
One of my favorite sources for macro information. His name is Hugh Hendry.
Hugh, welcome to the Rebel Capitalist Show.
Hugh Hendry: George, thank you. Thank you so much. It is great to be at rebel base camp.
George: All right, buddy.
So, for my viewers who might not know your backstory, can you fill them in on that, because it's really fascinating?
Hugh Hendry: Yeah. So, I set up a global micro hedge fund called Eclectica Asset Management in October 2002, so a long time ago.
I want to say that I achieved tenure, in the sense that I ran it for 15 years. Hedge funds are like restaurants. They're opening up all the time, and they're closing.
Hugh Hendry: We always write about the big returns that these damn hedge fund guys make.
No one has ever turned to the survivor, and no one talks about the guys who fail, because there are so many failures.
When I look back, and now I'm at one of those points in life where you look back for guidance, how did I get here? I take something very positive from the tenure.
Then, I was just different. I was not your regular hedge fund guy. I took ownership.
My marketing department would say, “Please, don't tell this story.” I'm not going to tell this story, but I was like a paranoid schizophrenic in terms of idea generation.
I had voices in my head, and it led me to take action.
Those actions were to invest other people's money on the basis of these voices. Then having done that, I was paranoid, and terrified.
Talk about safe custody, I watched those positions like a hawk, if you would.
The voices in my head really … I looked at charts, and charts became like cheap music, and I could, with the technology available, I could look at thousands of charts, and go through all the indices in the world, and all the asset classes.
There was a particular pattern I was looking for, and when I found out, I became very curious, and then I was very fortunate that I had this intelligence team. These street guys and girls.
And I could say, I'm crazy, but I think this thing is going to do a moonshot, this thing is going up.
I don't know why. I want you to go out into the world. I want you to investigate, speak to the experience.
Hugh Hendry: And make up your own opinion, and come back and challenge me. That's what we did, and for 15 years … I want to say we compounded.
I want to say that our average returns were between seven or 8%. I want to tell you that essentially that fund correlated to nothing. It was unique.
In the month of October 2008, I made a TV program for British Terrestrial Television, called Don't Bank on the Bailout.
If you go to YouTube, you'll be able to see excerpts of that. I made 50% for the month of October 2008, we made 50, for the year we made about 32%.
When I say we made seven or 8% on average, it was a function of those high years. Another high year we made 50% for the calendar year 2003, 17 years ago. A long time ago.
I was one of the first of the new generation to, again to say, “Hey, look, guys, I feel the vibration under my seat. Something is going on in the gold market. This could be a geyser. This thing is going to take off.”
Again, I don't know why, and of course I can find out, and we'll perhaps discuss it, because I think that was the first act.
I think the second act was a deflationary event, which was 2002, and I think, it also happens to be the virus.
But this is the third act in terms of the untold story of where gold has to go, and I'm sure we're going to explore that.
George: If I could just pause one moment just to unpack that a little bit.
When you say the deflationary event of 2002, when you use word deflation, what are you referring to specifically?
Are you referring to asset prices, a debt deflation, the value of the dollar going down at the DXY, or consumer prices?
Breaking Down Deflation in 2008
George: The reason I want to make sure we're clear there is because so many of my viewers, they see … I think everyone in the CNBC, you name it.
They see inflation or deflation as something that's completely binary. It's just either all prices are going up, or all prices are going down.
As you know, that often isn't true. There is nuance to it.
Can you explain to the viewers specifically what happened with the deflation during that time?
Hugh Hendry: Just at the end you made a very, very great point, which very few people truly understand.
It's one of these … Let me just say it, there is always a bear market somewhere. Even in the most grotesque of events, there is always a bear market somewhere.
I bound out a bit, I have so much energy in the morning, because I know just somewhere there is a bear market.
Now to your point, and again if I perhaps could just correct you, I said the deflation of 2008.
George: I'm sorry.
Hugh Hendry: For sure, of course, there had been an enormous deflationary event, which would be in the demise of the technology bubble from the year 2000.
I happened to launch my fund at the bottom of that bear market or risk concepts.
To your point, when I say a deflationary event, I am talking about an event whereby professional investors are feeling fearful.
Forgive me with this Scottish accent. I hope you put subtitles against me.
George: No, you're totally clear.
Hugh Hendry: I can speak French, but let's stick to English.
Deflation is when the so-called professional investors, when they're going, “Holy, I'm really fearful.” Which is to say, it's a moment when risk asset prices typically stop, market prices are falling.
Hugh Hendry: Now, why that becomes interesting? My world is a world of drama, it's a world of color, it's a world of theater.
Why it's an engaging avenue for me, an intervention point, is because it turns gray bureaucrats into swoosh sparkling buccaneers who want to save the world like James Bond.
Typically, and with respect … I don't mean that … It's so easy to demean our public officials.
Sometimes it's better to, sometimes it's not. I know in the golden, in the bitcoin community, there is a lot of hating, if you will.
And I always prefer to be a lover, we can always seek forgiveness. The guys who run the Federal Reserve, I want to say be mean good.
But these are people who are bureaucrats, they're not paid money like hedge funds guy, all right?
Hugh Hendry: They're not paid money to take risks. The biggest risk that they have is how history will judge their actions.
The central bank policies that we have seen since the stock market, and the housing marketing crash of 2008, again, these would be deflationary events.
I want to say that their actions were brave, and I want to paraphrase, brave means they were contentious.
That they were actions that were unconventional. Again, beyond their pay packet, and where they were potentially taking on the wrath of history.
That history could judge their actions to be wrong.
That would be a legacy for their family in the future. I think so far, kind of they choose the right path.
I know there is this tremendous and grotesque income disparity, but increasingly we're faced with alternatives which are not fantastic.
I would still want to say that the path they took averted a great depression part two, at the turn of the century.
After the unprecedented housing crash of 2007, 2008, we came so close to the American economy shrinking by 20%, and having an employment rate of 20%.
I think their actions prevented that from happening. They made errors etcetera.
Anyways, for me…
Deflation is an event that makes policymakers brave, and they take radical policy actions.
In 2000, I had closed out my possessions in gold, in about the end of 2005, because I said that we needed something really large, profoundly concerning, that would shake our economic principles and foundations to the core.
I imagined that it would be a synchronized house price decline across all the states in America, something that the experts said was impossible.
I thought… Life is all about the impossible becoming a reality.
I said that gold at that point would suffer, but you had to change the interest rate regime of the fed, because at the time, the Federal Reserve, I think interests rates peaked 5.25%, the official overnight fed funds rate.
I was saying for the second or third chapter to open up, we need this deflationary drama.
In order for the fed to follow the path of the bank of Japan, and cut interest rates, like radical, like desperate men trying to break out of prison.
And if we came down to zero interest rates, this is in 2005.
Hugh Hendry: I said, if you think the future is inflationary you have to buy treasuries because this terrible event is going to happen, the fed is going to slash rates to zero, and initially, people will find comfort in rising bond prices.
But then the next trip would be into gold. Forgive me, sometimes I can over-complicate these matters, but it's a wonderful drama.
One day we'll make a great book, or a great movie.
George: I'm very hard on the fed in my videos.
I will admit that if you're just looking at what's the best thing to do, to tie the economy over for the short term.
— Federal Reserve (@federalreserve) May 21, 2020
It's absolutely money printing or doing what they're doing.
A lot of people like Jeff Snyder that what they're doing is more psychological, but regardless of what it is, for the short term it is definitely beneficial.
I just get really concerned with the long term consequences of the fed continually expanding their balance sheet.
As an example, in 2007, beginning of 2008, it was around 800 billion. Then, just recently it was up to 4.5 trillion.
It went back down a little bit. But then we had the repo spike in September 17th, it started going back up. Now it's, who knows?
Seven, eight trillion, and it's probably on its way to 10 trillion-plus.
Hugh Hendry: I would say it's close to $50 trillion, truly measured it's close to 50 trillion.
The US economy is $18 trillion, the fed's balance sheet is like 3X the US economy in terms of numbers.
Is Federal Reserve Policy Really That Evil?
George: My point is. I know that we're all humans, and even if the fed's intentions are good, they're dealing with a complex system just like nature.
And there is no way they can just dial that thermometer in precisely, and there is bound to be unintended consequences.
My concern is that the unintended consequences are greater than the benefit of the short term gain. What do you think about that?
Hugh Hendry: I would come back to you with a question, what is the unintended consequences that really make you upset?
George: The currency, because I think at the end of the day that's most likely the release valve.
Although it doesn't happen immediately, I think once you get velocity in the economy, and once the fed, or the government is able to get the money growth in the actual back pockets of the individuals, then velocity picks up.
One thing that I really liked about what you said to Raul the other day in your conversation, is you pointed out…
In 2012, you thought, or a lot of people thought that there was going to be hyperinflation because the fed took their balance sheet to such extremes.
You pointed out that the velocity just tanked, just fell off a cliff.
So, you didn't see that type of inflation, because velocity was so low. Then, I think it through, and I say, “Why was velocity so low?” I'm thinking, and this is just a hypothesis.
It's just … It might have been because a lot of the money, the M2 growth went into the financial system.
Since the M2 growth goes into financial assets, it doesn't have as much velocity as it would if that entire, 100% of that M2 growth would have gone to the poor and middle-class people, to their checking account.
Then velocity increases, you get the inflation.
George: Maybe it's because I never studied economics, but I always come from a standpoint if there is no free lunch.
We just can't print consumption. If we do try to print consumption, at the end of the day there's going to be a negative consequence.
Maybe it's too much of a simpleton view, but that's kind of how I see it.
Hugh Hendry: If you would allow me to paraphrase what I think you just told me.
The thing that you push back against the fed, the things that's made you cross with the fed is that they have made us vulnerable to this unintended consequence.
Which would be a spike in the velocity of the circulation of currency within the American economy?
George: And the mal-investment too, the misallocation of resources and mal-investment.
Hugh Hendry: Okay. You say that can have long term consequences.
Would you accept that they have been pursuing this radicalization for just over 10 years now, from 2009?
We really haven't seen those unintended consequences as yet, because of the great surprise … I was on with my anger, in 2012, my anger, which began at the end of 2008.
I had seen the coming crash, and I had profited for my clients, and for myself.
I want … Like Andrew Mellon, the former treasury secretary from the late 1920s, I wanted them to purge the down system of its rottenness, all these rotten, corrupt, finance hedge fund people, clear the stables.
And we didn't. We chose another course, which was this funny money thing.
That cost me three years, of course, I made no money. If you remember, 2009, gold went from, I want to say it went form 500 bucks to almost … It went up four times.
I missed that, because I was angry, and I was calling names to the fed. I am not a moral guardian. I was the guardian of some rich people's money.
I was not the guardian of their moral principles, and it was not my role to call and shame other people.
It was ridiculous. The remarkable thing George is, here we are. We haven't seen an explosion in the velocity, in terms of the circulation of dollar bills in the US economy.
We haven't seen a debasement vis-a-vis other currencies in the world of the US dollar if anything.
The US dollar has traded higher vis-a-vis the euro and the yen, and the Aussie dollar, etcetera.
We haven't seen, it's not obvious we've seen an enormous mal-investment.
I mean, one could certainly question the amount of common resources being used to leverage bonds, used to buy back stock.
There is an argument that when the 10-year treasury rate is yielding zero, and you have a solid robust cash-flow generating business, the PE On that is really, really high.
Hugh Hendry: You could say that they're just buying these cheap perpetual equities.
Over 10 years none of that's happening, and yet we're still naming and shaming the fed.
That's how you got … One of the things you got to be careful when you're trying to invest in the kind of this emotional thing.
Just call a spade, a spade, and so far this system, the one thing that this radical monetary policy has done is, up until this dreadful virus, the US economy was rocking.
The dollar was strong. Anyone that wanted a job had a job. But, there is trouble coming. This is the third act.
George: Yeah. I'd still push back just a little bit.
Hugh Hendry: Push. Come on.
George: I think you've made a great point with the buybacks, and now we're seeing a lot of these companies go out of business because they don't have the resources to last them just for a month or two.
I think if you just look at these corporations just like you would your own personal balance sheet, and say, “Listen, it's prudent to have a rainy day fund.”
I think the main reason these guys don't have a rainy day fund is because of how the fed incentivized them to go into the market, and buyback their shares, because they got to go to further out the risk curve to get yield.
I'd look at pension funds as well. Especially.
These pension funds are so underfunded, because the fed drop rates down to zero for call it eight years, and they're accustomed to getting five or 6% on a treasury, which is called a risk free return.
They have to get a 7% return to meet their liabilities. You can't go eight years with the treasuries at 0% because then it affects all these state pension funds.
You look at what it does to savers. It goes back to Hazlitt's book, where you've got Economics in One Lesson, where you've got to look at the unseen.
I think if we somehow, although we can't, if we quantify, the negative effects of what happened due to quantitative easing, and keeping interesting rates artificially low for so long.
If we could quantify that with how many retirees now have to work at Walmart as an example.
You're in St Barts, but if you go to the United States, as an example, and Phoenix or Tucson, or Las Vegas.
If you go to your local Walmart, 50% of the people in there are over 80 years old.
I think that could potentially be a direct result of the fed, because these people build their lives on their savings, and their spending, and their consumption around them getting, because their financial planner tells them that they're going to be able to get a 7% return call it, for the rest of their lives.
If they can get a 7% return for the next 20 years, or they can increase their levels of consumption, they can do this and that, so they set up a budget for themselves.
After 10 years, if their financial planner comes back to them and says, “oh yeah, by the way, all that consumption that you thought you're going to have in retirement, you don't have anymore, because the fed dropped rates down to 0%.”
George: That's just another thing that I would throw out there.
I just think there is a lot of crosscurrents, and I'm concerned that the fed by taking those actions makes the system more fragile, the more action they take.
Although, in the short term, it definitely sews things over. This is your interview.
I don't want to talk too long. But that's kind of the tip of the iceberg.
Hugh Hendry: Of course. These are complex matters. Short term, is short term the last 10 years?
We pretty much [inaudible 00:22:53] for the last 10 years. Believe me, in 2008, that did not look a remote possibility.
I want to say that the fed achieved that. Should the fed be setting interest rates for the tiny, tiny probability that we have a global pandemic? I certainly hope not.
Should companies, should corporations be designing their balance sheet for the possibility of a pandemic? I don't think so.
Those folk who work in Walmart, it's complicated, you're right. When they came to retirement, they found that an annuity buys you nothing, in terms of an annual income.
But at the same time, if we roll the clock back to the Berlin Wall falling, and to the emergence of capitalism, and the spread of prosperity.
We freed billions of people from the serfdom of communism. We've got almost two billion Chinese people who are saying, “Thank you so much.”
But the cost of our generosity, sadly, is that if you were sitting there, and you were kind of through, no fire of your own, but you were what we call the unskilled labor force.
You find out you have a couple of million people overseas who are willing to do what you did for like pennies.
Was it the fed, or was it the fact that we liberated the world, and we asked them to join us in our wonderful economic system? Who knows? Time will tell, but let's go on.
Two Depressions: The 1920s And 1930s
George: No, Hugh, it's a fascinating conversation.
I love going back and forth. I also see it … I look at the depression of the early 20s, compared to the 1930s.
That's how I see it in my mind as well. Maybe you rip the bandaid off, you take more pain at the beginning, but you get through it in two years.
Hugh Hendry: It doesn't work. It really doesn't work.
George: Tell me why that doesn't work, because that really fascinates me.
Hugh Hendry: That's the ideology that I had. That's what they did, because … What do I want to say?
George: I want to be clear Hugh, just for the viewers, that there are two different …
We got to compartmentalize the conversation because there is one thing that's right and wrong to do for an investor, a trader, a money manager, someone that it's their job to get a return at all times regardless of what the fed is doing.
Then it's another completely different conversation to have what is the morally correct thing to do, or what's best for the economy over the next 20 years?
To your point, the money manager, the guy or girl trying to make money right now, they can't play that game.
They've got to just place their bets based on reality, not what they think should or shouldn't happen.
Hugh Hendry: You name-checked the depression.
The depression that began in the early years of the 1930s.
George: And 20s.
Hugh Hendry: Where was the depression in the 20s? The depression was in the 1930s.
George: No, 1920. Let me clarify, not necessarily a depression, but deflation.
You had unemployment down lower in 1920 than you had it at the beginning of the depression.
All the major statistics and metrics were worse in 1920 than they were at the beginning of what we consider the great depression.
Hugh Hendry: What I want to say to you is, what I was attempting to say is…
These periods of economic hardship are created by the ideology of the men and the women who set the course for the economy via setting interest rates, who work in the treasury, and who work in the Federal Reserve in the context of America.
It doesn't have to be, the events that you described in the early 1920s, were an ideology, it was the ideology of hard money, of the dollar being a great store of value.
And if the cost meant that your father, and his son lost their job, and the neighbor lost their job, so be it.
We were going to take every measure to have the sound, strong money was the most important thing.
This was a factor, because we had the first world war. Although the US had been on the sidelines, it had been using its factories to support and supply the effort against the Germans.
George: And the flu, and the Spanish flu.
Hugh Hendry: And the Spanish flu, absolutely.
I want to say there was a large fiscal moment, which is to say the government spent a great deal.
So there was the fear that we had expanded these paper liabilities, which could open up a temptation to print your way out of it.
All currencies were tied to the dollar, as all currencies are tied to the gold standard.
You had to put on this economic hero shirt, and do things to kind of, to beat down the economy, and to drive out all kind of speculative undertakings.
Kind of elderly people were at the sharp end of all of that. That, for all it does into … It was the hard-money ideology.
There is a lot of people who disagree with Benjamin Strong, who'd been the fed governor, and how he had been loosening money to help the Brits.
People said, “This is out of hand.” The stock market of course was kind of out of hand.
It had gone up a great deal. They thought they were engineering a recession.
They were increasing interest rates to stop the stock marketing appreciating, which I won't disagree with.
It so happened that because they were raising rates when there was a bubble. The bubble was a tremendously febrile environment, and they're hard to protect what happens next.
Of course, what happened next was, the thing crashed, it came down hard. It took out every commercial bank in the country.
You had to pull back and change policy. But instead with an ideology, treasury secretary Mellon is like, “This is great, purge the system of its rottenness. Let these banks fail. We're not bailing out anyone.”
Of course, that generation is sadly no longer with us, the generation that lost their jobs in the 1930s.
I would hesitate, if I was a policymaker, I would hesitate to inflict that on today's generation.
As what Bernanke said in, was it October 2003 when we had that helicopter speech?
George: 2002, yeah, I know what you're talking about.
Hugh Hendry: 2002.
He said, “Forgive me on behalf of the Federal Reserve. We've been wrong. We pursued the ideology of hard money, and sticking to the gold standard.
We allowed the great American worker to wither. That was wrong.
I tell you today, my promise today is, we're going to take every measure to make sure that doesn't happen in the future.”
That's the story of the last 10 years. I think that's been a success story, but I want to say, I'm very fearfully for the next 10 years.
I think when we turn this page, I think we're going to find that you and me, I think you're going to find that we're on the same page of the agreement on where we are today.
The Drastic Policies Of Paul Volcker
George: Hugh, how do you see what Volcker did?
Hugh Hendry: These are the tales of heroes, Volcker. And I kind of want to say in his own way, Bernanke.
They bookend a 50-year cycle in economic prosperity. It's a cycle, it's a bit like, we're on earth, and we go round the solar system.
We go around, we orbit the sun, and it takes us a year. Forgive me, I should be better on this.
I think if you are on Saturn or Neptune, I want to say you're farther away.
You have people watching and just going, “He doesn't know what he's talking about.” Stick with me guys.
If you know the answer, replace Saturn, or Neptune with the answer, but let's call it Neptune.
If you're on Neptune, I want to say it takes something like 18 earth years to go round, to complete one orbit.
Your perception of reality can be very, very different. You might have lived a life and never seen snow.
Because maybe as a child you grew up, and we had a mild winter, and you never saw snow.
You might never believe that happened. We had black swan, we talk about Black Swan events, because before we had commercial aircraft and everything else, Australia was …
I mean, even today, Australia is so far away. But of course in Australia they had swans, which were black. That was a very rare account.
I want to say to you that 50 years kind of like a human … Sure, today we live longer, we live between 70 and 80 years is the average for human life.
50 years is long enough, where those who knew, and those who gained the lessons from the last cycle, they began to die out, leaving all these merchants, like, “Hey, this is great.”
Now there are just very few people who lived through inflation as an example in the United States.
Hugh Hendry: Absolutely.
There are two cycles. I want to say there was a cycle that began with Henry Ford, and kind of concise with the first world war.
He had this revolution, he said, “Hey, I'm going to double the pay for my workers.” People said, “You're crazy. You're going to go bust! What are you doing?”
He was a genius, because he was giving a pay increase to the ultimate consumers of his product.
And they felt happy, their productivity was great. Productivity went up, he sold more, and he ended up making more.
So became the legend which was Henry Ford. Then like I said, we had this ideology of hard money intervened, we had a depression, they were lifted by a war.
Then we got into the 1950s, prosperity reemerged, and the American deal, and people moved into suburbs, and people were getting jobs.
Productivity surges, and profitability is really high.
That's the cycle where the corporation is doing well, but what you find is that labor, the pool of talent, the people who work every day, their share of the economy, of the pie, they're getting to eat every year, they're getting to eat just a little bit more, a little bit more, a little bit more, a little bit more.
Then you fast forward into the 1970s. At this point, labor is saying, this is no longer a function of me working hard.
This is actually … I deserve this. I merit, having a bigger and bigger slice of the profit, just because, and if you don't agree, we're going to organize ourselves into unions, and we're going to stop production, we're going to bring you down, if you don't agree.
We reached a point where labor had taken the capitalist system hostage, and was imposing a rent, which was, it was taking too much of the economy's upside out of the system.
Of course, we had lost all the dynamic arch. Why would you participate?
This would be like, Ayn Rand, and [inaudible 00:35:29]. This is the point where all the great entrepreneurs give up, and we all go, you say, “You keep the business, it's yours.”
We had marginal tax rates, which were 97, 98%. Again, if you're a great business person, great mind, you know what? Keep it.
Here are the keys to my business, I'm no longer interested. That cycle peaked right about the bankruptcy of the United Kingdom.
Remember when the United Kingdom had to go to the IMF, cup in hand, “Please sir, I'm sorry, we've run out of money.”
Can you imagine? That cycle ended.
Then we go back to your question, which was 10 minutes ago, you asked me about Volcker.
We've got heroes. Heroes entered the stage. They're heroes because they entered the stage as the cycle was about to change again.
George: Reagan, Thatcher, and Volcker
Hugh Hendry: Reagan, and Thatcher, and Volcker, and Milton Friedman.
A New Cycle Is Upon Us
Hugh Hendry: It wasn't quantitative easing, it was quantitative restrictions. It was quantitative reductions.
Inflation was on the roof, and we had new sheriffs, and they were brave. I mean, Volcker, really, you're talking about that guy?
He raised rates to bring on a recession, to bring down inflation.
That was feasible because it was 50 years ago, and the cycle was changing.
What I want to say is, what happened next, all of that worked, and inflation came off the ceiling, and now is on the floor.
It took 50 years, but the huge journey is complete. The capitalists, the people who own the businesses, from let's call it 1981, each year incrementally, they got to take more of the spoils.
Today, 50 years later, hand on heart, they're getting too much. Let's call them the creditors.
Just like the unions in the 1970s, who had imposed an economic rent on us, we now find it's not the unions, but it's these rich folks, who've built these barriers, and they're keeping us down in serfdom.
That cycle is changing.
Having Trump as president … I don't want to say that he's the new Reagan, but he is iconic, in terms of a new cycle.
The British rejection of the European Union, it's Trump, that's Trumpinism. That is iconic, that the cycle is changing.
Here we are, we've had this catastrophe, this pandemic, and it's revealing, that the state is getting bigger, bolder, and it's becoming more of a risk-taker, and it's beginning to reemerge into our lives.
Now everyone is dependent on the state.
The cycle is changing, and you better make sure that your portfolio is in sync with this new cycle.
This is a cycle, where the challenge, if you're a risk-taker, and you're wealthy, your number one challenge…
I was talking to someone recently, who is a confidant of the legendary David Tepper, the incredible money manager.
No one swung for risk more than David, a legend [inaudible 00:38:56] let's take it.
David is saying today, there is a time to take risks, but don't you forget, there is a time to preserve your capital.
That's kind of where we are with this cycle.
Why Did We Have Global Inflation in the 1970s?
George: Going back to the 1970s.
One thing it's really hard for me to figure out, because I've tried to figure out…
Why did we have inflation there?
You just hear the oil shock, and a lot of these things that people throw out, and you ask yourself, is that really what happened?
One thing that confuses me, is I look at almost every single country around the world, and they almost all had inflation.
I mean, you look at Saudi Arabia, you look at Japan. You look at all these other countries. It looked like it was a global phenomenon.
I have a hard time connecting all the dots in my mind, as to what actually caused this thing?
Because so many of the reasons we attribute to this inflation in the 1970s, was the US-specific.
Was this because the US was kind of the main economy?
It just had this trickle through effect with every other economy in the world?
What would you put the cause of the 1970s global inflation we experienced?
Hugh Hendry: Well, George, I got your back. I got the answers.
George: I got the questions. Give me the answers.
Hugh Hendry: You've got the questions. I've got the answers. Can I deliver the answer in a succinct manner? Let's try.
George: Remember, I've got some great editors Hugh. We can just edit it all together, and it will make us both look like geniuses.
Hugh Hendry: Let me see if I can do the genius thing on my own.
Banks, the answer is commercial private banks.
It's also the answer as to why despite all of this helicopter money from the Federal Reserve.
Despite the Federal Reserve's balance sheet today being 3X the US economy, being $50 trillion.
Despite that, we have no inflation today, but we had inflation in the 1970s.
Let's begin by talking about the banks. I told you about these cycles of 40 or 50 years, which [inaudible 00:41:14].
The banks had gone bust in 1930, 1931, 1932, and one of the lessons was that the banks had become too aggressive. They were taking too much risk, and in doing so, they had endangered the US society, and they brought on the depression.
The legislative challenge was to de-risk the banks. It's easy, you legislate for it.
For the next 40 years, from 1930 to 1970, you had incredibly tough regulations, which made it hard for banks to expand risk-taking on their book.
As you know, one of the most obvious examples was that a savings bank wasn't allowed to do investment banking. You had this, can't happen.
That's called an investment bank. You are a savings bank, a big a demark issue.
The second thing was, we were like, we got to make sure that the people who work for banks are just boring people, you take a salary, you don't get a share or profits.
You don't know what's on the percentage of the upside, you're working for the utility. By the 1960s, US banks were just a really great savings product.
You got like a 6% yield, and you just collect, it was a bond. Like for Europe, talking about those pension funds, and they need to get a 7% real return. What happened?
If you go back, I know you were talking to the legend, Jim Rogers.
Hugh Hendry: Jim maintains that his first trade with George was in recognizing that something profound was afoot with banks, that banks …
First of all, universities were beginning to run these MBA programs, and banks were starting to send their talent pool to these courses.
The kids were coming back and they were like, “I get it. I understand finance.”
George: Hugh, was this the late 60s?
Hugh Hendry: Late 60s, early 70s. George, the financial back was George Soros. George began his hedge fund in 1969.
The people who gave him the seed count were the people who gave me my seed count, so I know the stories quite well. George, it all coincides with this cycle thing.
Jim began to recognize that the banks, and the chief executives, the guys who were beginning to do presentations to investors were like nothing we had seen in 40 years.
There are always opportunities no matter what is going on…. https://t.co/Ew3iyaE5HM
— Jim Rogers (@JimRogerBlogs) May 18, 2020
They were starting to talk our language, the language of taking a better risk, making better money, but they were priced as utilities.
One of the first big equity, Soros trades was coming in was just buying these US banks who were radicalizing their leadership.
I'm saying to you, we had banks that wanted to take a risk. Secondly, you mentioned Saudi Arabia.
So we had, of course the oil price went shooting higher, the cartel, the ballpark.
When you repriced oil from 40 cents in the dollar to 12 bucks, or whatever the move was in 1973, 74, billions of dollars flooded into Saudi Arabia. Surplus was enormous.
It's like Japan in the 1980s. They've got to do something. What do they do? They buy treasury bonds of course.
Then financial revolution from these MBA guys at the banks, they create the eurodollar market.
The Saudis and these other oil-producing nations, they start putting their oil cash into the eurodollar market, which is financing US banks.
You got the coincidence of ambition
People who wanted to take risks leading the large US banks.
And you've got funding.
Which is to say you had an explosion in bank lending. When you have bank lending, M2, the broadest money supply definition series we have today, it takes off.
When M2 starts trending, prices and inflation go higher.
George: And velocity…
How did velocity behave back then Hugh?
Hugh Hendry: You've got velocity.
Velocity is nothing more than a culture, and a willingness to take risk by the private banking sector.
George: So, sort of a psychological phenomenon?
Hugh Hendry: Well, it's a psychological phenomenon to accept more risk.
Accepting more risk is to make another loan, to make another, to make a bigger loan, to make another, loans beget loans, beget loans, beget loans, beget loans. Certainly, that's your helicopter money.
That's the money that ends up in your pocket, and you think:
“I had a good week. Honey, I think we should go to St. Barts, I think we should blow the budget and spend money. I'm fed up with this wine, let's have some champagne. I'm fed up with this car. Let's just buy a limousine. Let's move to Beverly Hills.”
All of this was funded by banks. Since, 2008, lessons have not been learned.
After the housing debacle, the house price declined nationwide across America, which they told us could never happen, but it happened.
Policymakers said, “Gee, these banks, they're like enemy number one. They facilitated this. They put us in danger. We got to de-risk these guys.”
And so we started, we did this across the world. The thing that I dislike intensely is the Basel Agreement Number Three, to regulate the global banking sector.
It's like the Bible says, you have been a sinner, you must repent. In Europe, and in Japan they have succeeded in changing their banking sectors into utilities that don't want to take risks.
If we look at, let's choose the country of France, because I live back and forth in French territories, I know the data.
French banks loans have been growing 2% per annum for the last six, seven, eight years.
You aren't going to generate economic prosperity. You aren't going to get people into good jobs.
The people that are in jobs are not going to be able to get higher salaries and better jobs. You're in tenure. Again, I call it serfdom.
You're stuck, and life is gray, it's like black and white television.
Hugh Hendry: That's an ideology.
That's why you can print trillions of dollars if you're the Federal Reserve, but unless you ignite, and you change your ideology, such that you're willing to accept a risk-taking, and a vibrant US banking sector, you're never going to get ripped off.
That's why we had inflation in the 1970s. That's why we have not had it for the last 10 years.
George: I just want to clarify for everybody watching.
Part of what Hugh is talking about is the fact that the commercial banking systems create the majority of the money supply in the real economy.
In order for us to see great price inflation with a CPI, or in the goods and services in the real economy, and not just financial assets, there has to be a mechanism for transferring bank reserves.
Which the fed can print, 50 trillion, or a 100 trillion or whatever, and it just stays under their mattress so to speak.
It's just in the bank reserves, it's in the banking system, in the financial system, but the commercial banks have to take action.
Then of course consumers have to take action by there being demand for long, so there is a psychological component there.
I think it also goes back to … I'd love your take on this, correct me if I'm wrong. I think you've read Werner's book, you were saying that in your interview with Raul.
I think Werner's take on it, which I find fascinating, is that there were different rounds of quantitative easing back in 2008, or different methods.
There was the Japanese method that they did back in the early 90s, which Werner didn't like at all.
There was the Bank of England's approach, then there was the fed approach. I think what happened with the BOJ is that they didn't clean up the balance sheets of the banks.
Because they didn't clean up the balance sheets of the banks they weren't able to lend. It really stifled the lending that you're talking about.
The Importance Of The Consumer’s Balance Sheet In The Real Economy
I don't want to go off on a tangent, but my main question is:
To get this velocity in a real economy moving forward, how big of a factor is the consumer balance sheet to that?
Because if they're completely levered up, they can't take on any more debt even if they wanted to, and if their incomes are not rising fast enough to service the debt, how does that play into the equation?
Hugh Hendry: I believe it's called Say's law … He was a French economist.
France again, I'm on the French today. Say's law says that supply creates its own demand. He comes from, I want to say the 18th century.
Hugh Hendry: The best example of that is the Italian economy, they've always had lots of government debt.
I think today government debt is, I want to say 110% of the GDP. That's a big number for an economy. This is not Japan. Japan is bigger.
Japan is more economically professional, it's more productive.
George: And they can print their own money. Italy can't.
Hugh Hendry: And they can't print. That's a very, very true thing. You say that thinking, who is going to buy their stuff? Someone buys it.
Supply creates demand. My point is, I wouldn't worry. I think it's always nice to worry about everything.
But, in terms of being the catalyst item, I think the consumer balance sheet is the number one target, or issue here.
Again, it is … in Richard Werner's book, the Princes of the Yen. Again, basically I've been quoting him.
He was saying he was the originator of this term, quantitative easing.
George: Yeah, I know.
Hugh Hendry: He maintains that these are all programs or ideologies.
If you want to create a … If you want today to have a critique of the last five or so years is that inflation is below the target of all global central banks. It's too low.
If you speak to Raul, today, at Real Vision, he's terrified of deflation. Everything he says, if it eases it's going to take us up.
To Richard's point, which I keep just stealing is that, I can create inflation for you tomorrow. No problem. Tell me what rate you want. It's easy.
Virtually all economics since Ricardo been based on equilibrium paradigm.Key corollary: thesis that lower interest rates lead to higher economic growth. 1st empirical test of all classical,neoclassical,Keynesian, post-Keynesian, monetarist,new class econ: https://t.co/7Pej9bVh5g
— Richard Werner (@scientificecon) November 15, 2017
I would go back to the system behind it, as we saw Volcker at the Federal Reserve. I'd unwind of all my career's work, and I've introduced this thing called window of guidance.
I say, okay, choose a number. Let's say we've got 5,000 commercial banks in the US. You're bank number one, you're bank number two, I'm a bureaucrat.
Here is your allocation, I'm the government, and I dictate to you, that over the next year, I want you to expand your loan base by 10%.
If we have this conversation in one year's time, and I discover that you couldn't find enough people who were creditworthy, and therefore you tell me:
“Gee, I'm really trying. But we could only expand our loan bit by 2%.” You're fired. You've lost your buying prices.
Point number two, I hope you're hearing my conversation because here is your credit allocation.
I want you to expand loans to the great US consumer, like 10% per annum. If you fail to achieve that you're like this bozo next to me.
You're going to lose your buying prices. I tell you, in two years time, you'll have whatever inflation that you want.
Those banks, like in Japan, we all thought that … Again, we all had these cultural stereotypes, we thought the Japanese were great savers, and very prudent.
The banks had to expand their balance sheet between 1986, and 1989, when the Nikkei flared to 40,0000.
Hugh Hendry: The bank of Japan was saying to these banks, “You have to expand loans by 15%.” And they were like, “But that's impossible. We can't find anyone.”
The bank said, “I'm not listening. You have to do this.”
George: Why did they want to do that back then Hugh?
Hugh Hendry: They wanted to do that very simply. They wanted to do that because…
George: [crosstalk 00:54:33] anything to do with that?
Hugh Hendry: No, they were coming under huge political duress from the US government, because the US economy was strong, and Japan … Like China, Japan was the original China.
Hugh Hendry: Imports from Japan were wiping out.
This was when we saw the closure across the Midwest, all these steel plants and manufacturing, they were all going to Asia, and they were all going to Japan.
When then US picked up, suddenly, Japan was just getting richer, and richer, and richer.
And when you tried to export great American products to Japan, there was regulation after regulation, after regulation.
The US in the mid-1980s went, “Hold on, hold on, wait a minute. This has got to stop. If you don't make it stop. We're going to put quotas.”
What the Japanese decided, they said, “We've got to create a boom, a domestic boom, where our economy grows rapidly, because the consequences of that are, our consumers are going to buy American products.
Therefore, we'll get balance if you will in the current account, and the trade surplus will become less, and we will become less contentious to our American consumers and paymasters.”
They stopped a great, great boom, and it's very easy, you just instruct the banks to do what you tell them to do.
George: Then you got some serious unintended consequences of that one.
Hugh Hendry: Well, the stock market peaks at 40,000 and it spends the next 30 years in the bear market.
That's the consequence, but is that the consequence?
I would say to you, that what happened … I don't really have the hypothesis, we can go back and demonstrate, parallel universes.
The stock market peaked, kind of almost on the 31st of December 1989. It peaked because of the ideology, that word again, ideology changed.
The bank of Japan then became concerned at just how the nouveau riche, and how the basic cultural foundations of Japan looked as if they were being challenged by this easy money.
So they began to raise rates. Of course, they spent 10 years building a system based on more and more credit. Then they stopped taking credit. Then it went bang.
The Ideology by Japanese policymakers for 30 years, has kept the Japanese down, the ideology.
What Makes Japan So Different?
George: When you're talking about ideology, and keeping it down.
You're saying if they would have took Werner's approach, and cleaned up the balance sheets of the bank, then they would have been off to the races again?
Do you agree with me there, or do you have a different approach?
Hugh Hendry: I think you're misunderstanding Richard a little bit. I know he watches these things. I'm sure he will see it somehow.
George: Richard, if you're watching, you've got an open invitation for an interview.
I've asked him several times because I love his stuff. He's great.
Hugh Hendry: I am the brand ambassador of Richard. Richard's point is they cleaned up the banks.
George: They did?
Hugh Hendry: Yeah. The government took on all their debts. But in doing so, the government took the credit risk, but then it issued bonds to the Japanese nation.
So they were taking money out of the system. On the one hand, they were giving, on the other hand they were taking away. So kind of nothing.
You still had inertia. The Japanese economy as of, let's call it, 20 years, has been trapped by inertia.
Richard's point is, the economy, the debt now is like… I want to say government debt is 2.6 times GDP.
That's a high number, but hey, they can print.
If you want that to come down, the denominator has to start growing faster than the numerator.
This is what happened after the second world war. The denominator, the GDP grew very fast in America, and globally, because banks were lending money.
If Richard were talking to you, Richard would say, we could generate 5%, what is China's growth?
China's growth is 7% per annum. These guys have been playing in this tech spec for 25, 30 years. Japan could have that Chinese growth rate.
Anyone could be Chinese, in terms of their GDP growth rate, if you command, and direct your commercial banking sector to expand their loan book.
Let's call it 2X GDP, or 3X GDP. GDP is going to pick up.
We can do it, but it depends where you are with ideology.
It's typically ideology, and the fear of what happens if I do that what stops people from doing that.
George: You don't have a misallocation of resources?
Hugh Hendry: Yeah.
George: I mean, if you got the hurdle rate down at nothing, and you're throwing money at people, it just seems scarce resources with alternative uses.
Hugh Hendry: Sure. We're at a point where there is no…
George: Good answers, right?
Hugh Hendry: There is no good option. Every option comes with bad consequences.
You have very eloquently come out with the bad consequences of what I'm recommending, but let me throw it back to you.
Another bad consequence is … Trump is entertaining but kind of a [inaudible 01:00:35] guy, but you get Trump too. You get him for a second.
Governments get controlled by people who want to control your life, we move from democracies to something really, really horrible.
Whenever ideology has been worried about those unintended consequences of mal-investment, or a weak dollar, things like that, you end up getting worse.
You get people fighting each other. What I'd say to you is. I would always choose mal-investment over war. Like I say, be a lover, don't be a hater.
George: That's the ultimate mal-investment: War.
Hugh Hendry: Sure.
Why Having A Portfolio In Sync With Today’s Economic Times Is A Must!
George: All right Hugh, you've been really gracious with your time man.
I could go on, and on, and on about this stuff. This has just been one of the best interviews I have ever had.
I know that the viewers are going to be so angry with me if we don't get back to the one question.
You talked about your portfolio for the average Joe or Jane being in sync with current economic times, what did you mean by that?
What type of advice would you give to the average person watching this interview?
Hugh Hendry: I don't know about this term average, I don't like this term average.
To quote David Tepper again, there is a time to speculate, and there is a time not to speculate. This is not the time to speculate. This game has changed.
It used to be that the winning strategy, the thing that beat every expert like me, every pro looks like a dumb ass, when you consider the investment strategy of the permanent portfolio.
I'm sure at some point it's going to be on your whiteboard, and you're going to explain the concept or the balance sheet.
You're the biggest hedge fund in the world, rate or value, kind of plays this theme.
He doesn't like adjusting for risk, but you sit there with 25% of your portfolio in precious metals, gold, and maybe a bit of silver.
You sit there with 25% in the S&P, or maybe have a bit of NASDAQ or whatever. If you sit there with 25% in government bonds, you might have a little bit at the short end.
You might have a little bit in the long end.
You might even have a bit of a commercial. Then you sit there with cash and looking for opportunities, and you sit there.
That's strategy for the last 40 years has just wiped everyone. It's the leader, it's the Usain Bolt of whatever …
I don't know the American sporting analogies to make, but it has hit the ball out of the park, time after time, after time. It's finished.
This is a time to preserve capital.
Lastly, if you've got to have something, again, I'd say, don't have too much because it's going to test you.
This is a time which probably favors moving some gold, and you can buy it via an ETF or you can have the physical thing.
Gold is, I like to call it, it's hideously kinky.
I just like saying that it's hideously kinky. What I mean by that is it has a split personality.
It's like your best friend, and you're like, “God, I really love George.” Then you're like, “Now, I hate you. You're such a jerk.”
I'm like, “What happened to George? He was such a great guy yesterday.” Gold is a bit like that.
George: Like being married. It sounds like having a wife, right?
Hugh Hendry: I didn't say that. You said that.
As you know my wife, [inaudible 01:04:09] but anyway, look out my Instagram page for that story.
What I was trying to say is, that there are times when gold feels, it performs like a zero-coupon treasury, which is to say if Raul is correct, and ideology is still strong, and we have deflation.
Gold, it's just incredible. But before we get there, sometimes gold can flip.
In October 2008 when we had a deflationary event, when risk assets were falling, gold became, what would you call it?
It became like a tips, like an index-linked treasury coupon, which is to say it performed like a very highly weighted equity, which is to say it faux.
You got to be careful, and like I said, you probably should have a gold allocation, that you should be able to … Gold today, what price is gold today?
I should know this answer. Let's call it 2,000 bucks. That may be much. Gold could easily 1,500, 1,400, before it then goes higher again.
You got to promise, if you're going to have told you're going to be able to wear like a 20, 25% of your cut, before it then takes on. Be careful.
George: All right Hugh. Thank you very much for your time. I appreciate it.
For any of my viewers who want to find out more about your thoughts, or your incredible experience, or what you're doing right now, which we didn't even get the time to talk about.
I'll have to have you back on very, very soon to discuss all the neat things you're doing in the present.
But where can they go to find out more about you?
Hugh Hendry: I have started dropping Twitter bombs, tweet bombs, or whatever, under @Hendry_Hugh, but my passion is … I'm trying to build an Instagram.
I do things the wrong way around. I don't know why I make it hard for myself, because I know that finance people don't feel comfortable on Instagram, but it's fun, and let's make life fun.
I'm Hugh Hendry Official. Join me on Hugh Hendry Official. I've got 2,5000 followers.
I promise you, it's going to be entertaining, and maybe just maybe, you might learn something.
George: Fantastic Hugh. I can't wait to do it again buddy.
Hugh Hendry: Thank you. Thank you George.